Calculate the Beta of a Stock

Description
Beta is a statistical measure that describes the volatility of a stock or investment relative to the overall stock market. Beta represents the stock's incremental risk to a diversified investor, where risk is defined as the extent to which the stock moves up and down in conjunction with the aggregate stock market. A beta of 1 indicates that the stock's price is as volatile as the market as a whole, while a beta greater than 1 indicates that the stock is more volatile than the market, and a beta less than 1 indicates that the stock is less volatile than the market. Beta is a crucial input in the Capital Asset Pricing Model (CAPM) that helps investors to determine the expected return on an investment given its level of risk.


Beta is calculated by comparing the returns of a particular stock or investment to the returns of the overall market over a specified period of time. The formula for beta is:
Beta = Covariance of the Stock's Returns and the Market's Returns / Variance of the Market's Returns
The numerator of the formula measures the degree to which the stock's returns move in tandem with the market, while the denominator measures the overall variability of the market.


When using a single company's beta, the estimation errors can arise due to several factors such as market volatility, company-specific events, and measurement errors. These factors can lead to noisy and unreliable beta estimates, which can impact the accuracy of the expected return calculation.
To reduce the noise around beta estimates, it is better to use industry betas. Companies in the same industry face similar operating risks, and therefore they should have similar operating betas. By using industry betas, estimation errors across companies tend to cancel out. The industry median (or average) beta can then produce a superior estimate that is more accurate than a single company beta.
Beta takes into account not only the company's operating risk but also its financial risk, which is reflected in its capital structure. A company with a higher amount of debt will face greater financial risk due to the increased likelihood of default or bankruptcy. As a result, the company's beta will be higher to reflect the additional risk associated with the company's capital structure. Therefore, to compare the betas of companies with similar operating risks, it is necessary to adjust for differences in financial leverage (calculate unlevered Beta).


This template assumes that Beta of capital for tax shields (Btxa) = unlevered Beta of equity (Bu). Therefore, the formula used for unlevering Beta is the following:
Bu = Be* E/EV + Bd * D/EV