# Calculating Unlevered Beta When Evaluating Stocks

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Investors who are new to beta calculations may believe that this is a data indicator used by traders who take market positions based on technical analysis. While it is true that calculating beta can be useful in measuring the potential sensibility of stocks during periods of market volatility, traders who stick to fundamental analysis also perform this calculation for the purpose of assessing portfolio risk.

Beta is a coefficient measurement, which means that it must be compared to benchmarks such as the performance of industry groups or the S&P 500 index. The essential comparison is risk versus risk; the beta of Microsoft shares during the first week of April 2018 was 1.32, which means that it may outperform the S&P 500 by 0.32 percent because a beta of 1.00 percent suggests long-term stability. A beta of 2.00 percent would suggest that a stock is expected to perform better than the S&P 500 by a significant margin.

The reason fundamental analysts pay attention to beta is because is based on the Capital Asset Pricing Model, which is a very respected tool in the field of finance accounting. The reason technical analysts follow the beta of equity securities is because it can also be based on historical values, thereby indicating trading behavior and opportunities to take market positions.

Unlevered beta can be used to measure the risk that a company without significant debt obligations faces in the stock market. When a company manages substantial leverage, it must use earnings to pay off debts, which means that shareholders are second to the company’s priorities since creditors must be paid first.

The first step in calculating the unlevered beta of a stock is to obtain the beta; a good source would be Bloomberg, MarketWatch or the data feed provided by retail stock brokerages such as Fidelity and E*TRADE. The next step is to look at the financial statements and find the taxation rate, the company’s debt and its equity. The formula is as follows:

* Unlevered beta = Beta / [1 + (1 – Rate of Taxation * Debt / Equity)]

Since unlevered beta mostly focuses on the assets of companies, it can be an overly optimistic measurement. A better way to interpret unlevered beta is to approach it cautiously as a measurement of how the company would stand to the systematic risk of the market.

An interesting situation related to beta was experienced on Wall Street over a few trading sessions in February 2018. The issue was centered on a couple of exchange-traded funds that track the market volatility index known as VIX. These highly technical ETFs exhibited very high betas when compared to the overall market, thus attracting the attention of quite a few traders. Calculating the unlevered beta of these securities makes sense because they operate with negligible debt levels; nonetheless, they are atypical operations. Despite their high betas, market volatility and high frequency trading got the best of these ETFs, which ended up bringing down Wall Street and forcing a correction.

In the end, unlevered beta will work better for investors who are analyzing companies that operate in traditional industries, and which have little exposure to debt.