Unlevered beta

Unlevered beta measures the market risk of the business itself, separated from the way it is financed. The beta observed on the exchange measures how the share moves, and the share of a heavily indebted company moves more sharply than its operations do: interest on debt is paid regardless of revenue, so the residual profit left for shareholders fluctuates more widely. Unlevered beta answers the question of what this sensitivity would be if the entire balance sheet rested on shareholders' equity.

How debt amplifies observed beta

The link is set by the debt-to-equity ratio. Observed beta equals unlevered beta multiplied by a factor in which one is added to the product of that ratio and the difference between one and the corporate income tax rate. The tax adjustment appears because interest reduces the taxable base, so part of the debt burden is absorbed by the state. To obtain unlevered beta, the operation is reversed: observed beta is divided by the same factor, using the debt and equity of the company whose beta was measured.

In practice, beta is rarely taken from the company being valued: it may have no trading history, or its free float may be too small, so the share price lives a life of its own. Instead, comparable listed companies are used: their betas are stripped of their debt, averaged, and the result is relevered with the debt of the company being valued. The resulting beta feeds into the CAPM, and from there into the WACC and a DCF valuation.

An example using the site's data

Unlevering requires two balance-sheet lines. The site shows Rosneft's total debt as follows — no data; equity is taken from the same company page, and the ratio of the two becomes the leverage in the formula. The higher this ratio, the further the unlevered beta will fall below the observed one: part of the share's market volatility is explained not by the business but by the financing structure.

When unlevered beta misleads

The main error is treating unlevered beta as the company's "true" beta and plugging it into the calculation of the required return on equity. It describes the risk of the assets, whereas a shareholder holds a stake in the assets net of debt, so for the shareholder the beta must be relevered to the actual capital structure. The second case in which the measure is empty is a company with no debt: unlevering changes nothing for it, and any gap from the observed beta merely reflects noise in the quotes and shows that the measured volatility reflects infrequent trades rather than a link to the market.