Beta is a statistical measure that compares the volatility of a stock against the volatility of the broader market, which is typically measured by a reference market index. Since the market is the benchmark, the market's beta is always 1. When a stock has a beta greater than 1, it means the stock is expected to increase by more than the market in up markets and decrease more than the market in down markets. Conversely, a stock with a beta lower than 1 is expected to rise less than the market when the market is moving up , but fall less than the market when the market is moving down. Despite being rare, a stock may have a negative beta, which means the stock moves opposite the general market trend. Fauji Fertilizer Co., Ltd. shows a Beta of N/A. This is significantly lower than 1. The volatility of Fauji Fertilizer Co., Ltd. according to this measure is significantly lower than the market volatility.
Beta calculation details The calculation divides the covariance of the stock return with the market return by the variance of the market return thus: beta = cov(ri.rm) / var(rm) where stock return ri = (stock price at time w / stock price at time (w-1))-1 market return rm = (index at time w / index at time (w-1))-1 E(ri) = arithmetic mean of stock returns E(rm) = arithmetic mean of market returns covariance cov (ri,rm) = sum [ri-E(ri))*(rm-E(rm))]/count(ri-E(ri))*count(rm-E(rm)) variance var(rm) = sum[(rm-E(rm))^2]/count(rm-E(rm))^2
Standard beta is co-called levered, which means that it reflects the capital structure of the company (including the financial risk linked to the debt level). Unlevered beta (or ungeared beta) compares the risk of an unlevered company (i.e. with no debt in the capital structure) to the risk of the market. Unlevered beta is useful when comparing companies with different capital structures as it focuses on the equity risk. Unlevered beta is generally lower than the levered beta. However, unlevered beta could be higher than levered beta when the net debt is negative (meaning that the company has more cash than debt). Many different betas can be calculated for a given stock. The main common variables that affect beta calculations are the time period, the reference date, the sampling frequency for closing prices and the reference index. The calculation divides the covariance of the stock return with the market return by the variance of the market return. Beta is used very often for company valuation using the Discounted Cash Flows (DCF) method. The discount rate is calculated using the Weighted Average Cost of Capital (WACC). The WACC is essentially a blend of the cost of equity and the after-tax cost of debt. The cost of equity is usually calculated using the capital asset pricing model (CAPM), which defines the cost of equity as follows: re = rf + β × (rm - rf) Where: rf = Risk-free rate β = Beta (levered) (rm - rf) = Market risk premium.