Unlevered Beta

Below is an explanation of unlevered beta (asset beta), how to calculate it, and what it's used for.

What is unlevered beta?

Beta is a measurement that compares the volatility of a company’s stock against the broader market. In other words, it’s a measure of risk. Beta allows investors to gauge how sensitive a security might be to macroeconomic risks.

Unlevered beta is the beta of a company minus the impact of debt. It is also known as the volatility of returns for a company, without taking into account it’s financial leverage. It compares the risk of an unlevered company to the risk of the market. This is also commonly referred to as “asset beta” because the volatility of a company without any leverage is the result of only it’s assets.

When you look up a company’s beta on Bloomberg the number you see is levered to reflect the debt of that company. However, each company’s capital structure is different and we want to look at how “risky” a company is regardless of what percentage of debt or equity it has.

The higher a company’s debt/leverage, the more earnings from the company that are committed to baying back that dept. As a company adds more and more debt, the company’s uncertainty of future earnings is also increasing. This in turn increases the risk associated with the company’s stock; however, it is not an aspect of market risk. Therefore, subtracting the financial leverage (debt impact), the beta can capture a more appropriate market risk.

How do you calculate unlevered / asset beta?

To determine the risk of a company without debt, we need to un-lever the beta (i.e. remove the debt impact).

To do this you look up the beta for a group of comparable companies within the same industry, un-lever each one, take the median of the set, and then lever it based on your company’s capital structure.

Then you use this Levered Beta in the cost of equity calculation. For your reference, the formulas for un-levering and re-levering Beta are below:

Unlevered Beta = Levered Beta / (1 + ((1 – Tax Rate) x (Total Debt/Equity)))

Levered Beta = Un-Levered Beta x (1 + ((1 – Tax Rate) x (Total Debt/Equity)))

If the unlevered beta is positive, investors will want to invest in it when prices are expected to rise. If the unlevered beta calculation is negative, investors will want to invest in it when prices are expected to fall.

What is it used for?

Unlevered beta is used to measure the risk of a security minus the company’s debt.

It is best to use unlevered beta when either a company or an investor wants to measure a company’s performance in relation to the market without the impact of a company’s debt.

In relation to levered beta, unlevered beta takes out the impact of a company’s debt. This makes it naturally lower than levered beta and in turn, it is more accurate in measuring its volatility and performance in the market as a whole.

Unlevered beta is commonly used in financial modeling and business valuation for professionals working in investment banking or equity research.