Beta
Beta is the sensitivity of an investment's return to the market's: a beta of 1.0 moves with the market, 1.5 half again as much in both directions, 0.5 half as much. It measures the risk diversification cannot remove — the market's own — and in the capital asset pricing model it scales the equity premium, so a fintech at 1.4 is discounted at a higher rate than a utility at 0.6.
- Also known as
- Market beta, Equity beta, Systematic risk
- Used at
- cost-of-equity estimates in every valuation; portfolio risk management; manager evaluation (alpha is what remains after beta); index and factor investing
- Binding
- no — a statistic from regressing the asset's returns on the market's, usually over two to five years of weekly or monthly data
- Typical values
- listed payment processors 1.1–1.4; banks 1.0–1.3; high-growth fintech platforms 1.5–2.0; utilities and consumer staples 0.5–0.8; the market by definition 1.0
- Typical adjustment
- a private company has no beta of its own, so valuers take listed comparables' betas, strip out their leverage (unlevered beta), and re-lever for the target's own debt — because debt magnifies equity risk
- Parties
- analysts and valuers, portfolio managers, and the data vendors (Bloomberg, Refinitiv) whose beta estimates differ by method
How beta works in practice
A payments company's shares are regressed on a broad index over three years of weekly returns: the slope is 1.3 — when the market moves 1%, the shares move 1.3% on average. Its cost of equity, with a 3.5% risk-free rate and a 5.5% equity premium, is 3.5% + 1.3 × 5.5% = 10.7%. A rival with a beta of 0.9 is discounted at 8.5%; the same cash flows are worth more in the rival's hands, because the market judges them less exposed to its swings.
For a private fintech the number is borrowed. The valuer takes four listed comparables, computes each one's beta, unlevers it for that company's debt-to-equity (beta rises with leverage, since fixed interest makes equity returns swing more), averages the unlevered betas, and re-levers for the target's capital structure. A private payments company with no debt might carry an unlevered beta of 1.1; the same company after a buy-out at 50% debt has an equity beta near 1.7, and a cost of equity five points higher — which is the arithmetic behind why leverage raises the required return and not just the risk.
Beta measures only the risk the market shares. A single company's own risks — a sponsor bank, a regulator, a key customer — are not in it; they are diversified away in a portfolio and priced separately in a valuation of one company.
Example
A valuer estimates the equity beta of a private lending platform with €40m of debt and €80m of equity. Comparables: four listed lenders with equity betas of 1.2, 1.4, 1.1 and 1.5 and debt-to-equity ratios of 0.3–0.8; unlevered (at a 25% tax rate) they average 0.95. Re-levered for the target's 0.5 debt-to-equity: 0.95 × (1 + 0.75 × 0.5) = 1.31. Cost of equity: 3.5% + 1.31 × 5.5% = 10.7%, plus a 3% size premium and 2% for the company's own risks: 15.7%. A colleague who used the comparables' levered betas directly — 1.3 average — arrived at 15.65% by accident; a third who took the single highest comparable's 1.5 produced 16.8% and a valuation 8% lower, which the deal team preferred and the committee did not.
Common mistakes
- Using a comparable's levered beta for a target with a different capital structure. - Betas from different data vendors, periods and frequencies mixed in one valuation. - Reading beta as total risk; it is the market's share of it. - A beta estimated over a period that included one extraordinary year. - Treating beta as a property of the company rather than as an estimate with a standard error of 0.2 or more.