Friends Let’s
Learn about Beta.
1. What is Beta
Simply we can say that Beta is a Relative Risk Measure
of Riskiness of a business in Relation to Market.
Beta tells that how much a stock is risky as compare to the
market. Market’s Beta is always 1 Then is any company’s beta is more than 1
then it means that company is riskier than market and if it is less than 1 then
it means the company is less risky than market.
Beta tells that how much a stock moves compared to the overall
Market.
2. Simple Example
Market means Market Index Like Nifty 50 or Sensex, now as
mentioned Nifty 50 or Sensex Beta is 1
Case 1. If any company’s Beta is 1.5 than if market goes 10%
up than stock goes up 15% (more risky, moves faster)
Case 2. If any company’s Beta is 0.5 than if market goes 10%
up than stock goes up 5% (less risky, moves slower)
Case 3. If any company’s Beta is negative means if market
will go up than stock will go down. Stock actions opposite to market (like gold
or hedging assets).
3. Why Beta is Important?
CAPM model – Beta is used in CAPM model to calculate Expected
return of a stock (Ke = Cost of Equity)
Investors – Beta helps investors to take decision if the
stock is risky or safe for investing purpose.
Portfolio Management – Beta is useful to analyse the risk and
balance or diversify the risk.
4. Beta calculation methods
A) Historical Beta
Calculation (Most
Common) - Collect past returns of stock and past returns of market index (like
Sensex or Nifty 50). And use the below formula using MS Excel (covariance ÷
variance).
Covariance → How stock and market
move together.
Variance → How much the market itself moves.
B) Regression Method (Line
Slope Method)
· Plot stock returns (Y-axis) vs market
returns (X-axis).
· Draw a line of best fit (regression
line).
· The slope of the line = Beta.
· This is what Bloomberg, Money control,
Yahoo Finance use.
C) Bottom-up Beta (for new companies / private firms)
· If company is start up or a new
company and it is not listed in stock market then we take industry Beta.
· Adjust it with company’s debt and equity (because risk changes due to leverage changes).
Formula used:
Unlevered Beta = Industry
Beta ÷ (1 + (Debt/Equity))
Levered Beta = Unlevered
Beta × (1 + (Debt/Equity of company)
D) Proxy Method (Quick Estimate)
If detailed data is not
available, use similar company’s Beta as proxy.
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