What Does Beta Mean?
Beta is a measurement of the systematic risk of a firm’s common stock. It is a ratio used to evaluate the firm’s performance. Asset beta is the unlevered beta, which is a measure of the business risk, and equity beta is the levered beta which is a measurement of financial risk. If beta is >1, the target stock is more volatile than the market; if beta is <1, the stock is less volatile.
Divestopedia Explains Beta
Risk is the degree of uncertainty associated with the outcome of an investment.
Business risk is the risk associated with the firm’s operations and is affected by the firm’s investment decisions. So, return on assets = risk free rate + business risk premium.
Financial risk is the risk associated with a firm’s capital structure and is affected by a firm's financing decisions.
Risk may be diversified or non-systematic, such as defaulting on debt repayments. These are specific to a firm. Non-diversified or systematic risks, such as inflation, affect all the firms.
Beta is a measure of the extent to which a firm’s returns change because of a change in the market returns. It represents an estimate of the fluctuation in value of a stock in relation to the market as a whole. Return on equity or return on assets is given by the equity beta (levered) or asset beta.
Beta is generally estimated using regression techniques on historical data. When historical data is not available, comparable figures for the industry are used and adjustments are made for leverage.
In an acquisition, the acquiree may significantly increase the target firm’s debt level. The target’s levered beta, which reflects pre-acquisition leverage, must be converted to unlevered beta to reflect the firm's operating leverage. The resulting unlevered beta is used to estimate the risk associated with new borrowing by re-levering it to reflect post-merger capital structure.