What is 'Unlevered Beta'
Unlevered beta compares the risk of an unlevered company to the risk of the market. The unlevered beta is the beta of a company without any debt. Unlevering a beta removes the financial effects from leverage. This number provides a measure of how much systematic risk a firm's equity has when compared to the market.
BREAKING DOWN 'Unlevered Beta'
Unlevering the beta removes any beneficial effects gained by adding debt to the firm's capital structure. Comparing companies' unlevered betas gives an investor a better idea of how much risk he is taking on when he purchases the stock.
In finance, beta is a measure of risk. Specifically, it is the slope of the coefficient for a stock regressed against a market index like the Standard & Poor's (S&P) 500 Index. Unlevered beta removes the impact of debt or leverage on the regression.
Beta is a statistical measure that compares the volatility of a stock against the volatility of the broader market. If the volatility of the stock, as measured by beta, is higher, the stock is considered risky. If the volatility of the stock is lower, the stock is said to have less risk. A beta of 1 is equivalent to the broader market. That is, a company with a beta of 1 has the same systemic risk as the broader market. A beta of 2 means the company is twice as volatile as the overall market, but a beta of less than 1 means the company is less volatile and presents less risk than the broader market.
Unlevered beta provides the same information as beta, but it removes the impact of debt from the equation. The more debt or leverage a company has, the more earnings are committed to paying back that debt. This increases the risk associated with the stock. While leverage is an aspect of risk that should be monitored, it is not an aspect of market risk.
Unlevered beta is a metric that removes the impact of debt from beta. It is calculated by dividing the levered beta by 1 and then subtracting the tax rate, multiplied by the ratio of debt to equity, plus 1. As a mathematical formula, it looks like this: unlevered beta = beta / 1 + (1 - tax rate) x (debt / equity). The tax rate is the firm's corporate tax rate. Debt and equity are both found on the balance sheet.