The unlevered beta is a way of comparing the risk involved in investing in a particular firm with the risk of investing in the entire market. Unlevered means that debt is removed from the calculation. This in turn removes the effects of leverage and thus gives a more accurate picture of the comparative risk.
A beta is a way of measuring the systematic risk of a particular investment. The beta can be positive, negative, or zero. Respectively this indicates the investment will move in line with the market as a whole, against the market as a whole, or is unrelated to the market's movements. The main cause of a company's beta is whether investors put more weight in its financial performance, such as revenues and profits, than they do in the overall pattern of buying and selling in a market.
The beta helps distinguish between risks specific to a particular company stock and more general investment risks. For example, a sports team franchise may suffer pressure on its stock if there is a recession and consumers are less able to buy tickets, but this will also affect many, and probably most, other stocks. The franchise may also be subject to more specific risks, such as whether or not it receives prize money or added ticket sales income if the team progresses from the regular season to play-off games.
One limitation of the beta is that it does not take account of leverage. This is where a company borrows money, meaning it needs to raise less cash through stock issues. In turn, there are fewer shares and thus any profits or losses appear much greater when calculated on a per-share basis. This can distort how risky the company appears when a beta is calculated. The unlevered beta takes account of this by adjusting the figures to remove the effects of this debt.
Calculating the unlevered beta involves dividing the beta by a figure produced by the equation [1+(1-TC)x[D/E]. In this equation, TC is the corporate tax rate paid by the company. D/E is the ratio of debt and equity for the company. In the context of the unlevered beta calculation, equity is the total value of shares. This is the number of shares multiplied by the value of those shares, usually the face value rather than the current market value.
