Beta of Equity

Individual stocks tend to be more or less risky than the overall market. The riskiness of a stock, measured by the variance of its return relative to the market's return is indicated by an index called “beta” (ß).

  • If ß = 1, the stock's return fluctuates identically with the market's return.

  • If ß, then 1, the stock's return varies more than the market's return, and therefore its risk exceeds that of the market as a whole.

  • If ß < 1, the stock's return varies less than the market's return, and therefore its risk is less than that of the market as a whole.

For example, if a stock's return normally moves up or down 1.2% when the market moves up or down only 1%, the stock has a beta of 1.2. The beta is used to calculate the Cost of Equity (the return expected by stockholders) as follows:

Cost of Equity = Risk Free + Beta * Market Risk Premium

Public Companies

Beta estimates are published by a number of brokerage and advisory services, including Value Line and Merrill Lynch. Check the beta listed in one of these services as a measure of the company's past riskiness.

Private Companies

Check the betas listed in the preceding services for public companies that might be expected to share degree of market risk.

Beta is a past measure of riskiness. When making future projections, you should consider anticipated changes in the company's business or financial risk profile.

Note:

If the company's Target Debt Capacity changes or you estimate a beta based on the beta of another company, you may need to adjust the beta for difference in financial risk. This is known as “unlevering” and “relevering” the beta.