Beta Coefficient

Article byWallstreetmojo Team
Edited byAshish Kumar Srivastav
Reviewed byDheeraj Vaidya, CFA, FRM

What is Beta Coefficient?

The beta coefficient formula is a financial metric that measures how likely the price of a stock/security will change concerning the movement in the market price. The Beta of the stock/security is also used for measuring the systematic risks associated with the specific investment.

The beta is the degree of change in the outcome variable for every 1 unit change in the predictor variable. A standardized beta compares the strength of the effect of each independent variable to the dependent variable. The greater the absolute value of the beta coefficient, the stronger the impact will be.

The beta formula is used in the CAPM model to calculate the Cost of EquityCalculate The Cost Of EquityCost of Equity (Ke) is what shareholders expect for investing their equity into the firm. Cost of equity = Risk free rate of return + Beta * (market rate of return - risk free rate of return). read more as shown below –

Cost of Equity = Risk Free Rate + Beta x Risk Premium

Key Takeaways

  • The beta coefficient formula is a tool used to gauge a stock’s susceptibility to market fluctuations and evaluate investment risks. It measures how much the stock’s outcome changes for each 1 unit change in the market. 
  • Beta plays a vital role in the Capital Asset Pricing Model (CAPM), a method used to determine the expected rate of return for a specific stock or portfolio based on its risk in relation to the market.
  • A negative beta investment moves inversely to the overall stock market. When the market rises, a negative beta investment tends to fall, and vice versa. 

Beta Coefficient Meaning

The Beta is calculated in the CAPM modelCAPM ModelThe Capital Asset Pricing Model (CAPM) defines the expected return from a portfolio of various securities with varying degrees of risk. It also considers the volatility of a particular security in relation to the market.read more (Capital Asset Pricing Model) for calculating the rate of return of a stock or portfolio.

Beta Coefficient

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The Beta calculation in excel is a form analysis since it represents the slope of the security’s characteristic line, i.e., a straight line indicating the relationship between the rate of return on a stock and the return from the market. It can further be ascertained with the help of the below Beta formula:

β = Covariance of Market Return with Stock Return / Variance of Market Return

The meanings of beta coefficient –

  • If the coefficient is 1 it indicates that the stock /security price is moving in line with the market.
  • If the coefficient <1; the return of the security is less likely to respond to the market movements.
  • If the coefficient > 1, the returns from the security are more likely to respond to market movements, thereby also making it volatile;
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Beta Coefficient Example

If Apple Inc’s (AAPL) beta is 1.46, it indicates that the stock is highly volatile and 46% more likely to respond to market movement. On the other hand, say Coca-Cola has a β coefficient of 0.77, indicating the stocks are less volatile and 23% less likely to respond to movement in the market.

As a trend, it has been observed that utility stock has a CAPM Beta CAPM Beta CAPM Beta is an essential theoretical measure of how a single stock moves with respect to the market. In this method, we determine the cost of equity by summing up the beta and risk premium product with the risk-free rate.read more of less than 1. On the other hand, technology stocks have a Beta coefficient of greater than 1, indicating a likelihood of higher returns with more associated risks.

Beta Coefficient Calculation

Here we will take an example to calculate the beta of MakeMyTrip (MMTY) and the Market index as NASDAQ.

You may download the fully solved Beta Calculation Excel Worksheet from here.

There are three Beta formulas – variance/covariance method, slope function in excel, and regression formulaRegression FormulaThe regression formula is used to evaluate the relationship between the dependent and independent variables and to determine how the change in the independent variable affects the dependent variable. Y = a + b X +read more. We will see each of the beta coefficient formulae below –

Step 1 – Download Historical prices and NASDAQ index data from the past 3 years

I have downloaded the data from yahoo finance.

  1. For the NASDAQ dataset, please visit this link Yahoo Finance.
  2. For Makemytrip prices, please visit this URL here.
NASDAQ Historical Prices Download

Step 2 – Sort the Prices as given below

Sort the dates and adjusted closing prices in the ascending order of dates. You can delete the remaining columns as we don’t need those for beta calculations in excel.

Beta Calculation - Step 2

Step 3 – Prepare the beta coefficient excel sheet as per below.

Beta Calculation - Step 3

Step 4 – Calculate Daily Returns

Return = [Closing share price – Opening share price] / Opening Share Price

Beta Calculation - Step 4

Step 5 – Calculate Beta Formula using the Variance-Covariance method

You need to use the two formulas (variance and covariance in excel), as shown below.

Beta Calculation using Variance Covariance

Using the variance-covariance method, we get the Beta as 0.9859 (Beta Coefficient)

Step 6 – Calculate Beta using SLOPE Function in excel

Beta Calculation using SLOPE Method

Using this SLOPE function in excelSLOPE Function In ExcelThe Slope function returns the slope of a regression line based on the data points recognized by known _y values and known _x values.read more , we again get the Beta as 0.9859 (Beta Coefficient)

Step 7 – Calculate Beta Coefficient Regression

To use this regression function, select Data analysis from the Data Tab of your Excel Worksheet.Data Analysis

If you cannot locate Data Analysis in Excel, you need to install the Analysis ToolPak. This process is relatively easy: Go to FILE -> Options -> Add-Ins -> Analysis ToolPakAnalysis ToolPakExcel's data analysis toolpak can be used by users to perform data analysis and other important calculations. It can be manually enabled from the addins section of the files tab by clicking on manage addins, and then checking analysis toolpak.read more -> Go -> Check Analysis ToolPak -> OK

Select Data Analysis and click on Regression

Data Analysis - Regression

Choose the Y Input Range and X Input Range

Regression Range

Once you click OK, you get the following Summary Output.

Regression Output

You will get the same Beta in each of the three methods.

Advantages of Beta Coefficient Regression

CAPM estimates an asset’s Beta based on the systematic risk of

  1. The market. It is used for beta regression to estimate the Cost of EquityCost Of EquityCost of equity is the percentage of returns payable by the company to its equity shareholders on their holdings. It is a parameter for the investors to decide whether an investment is rewarding or not; else, they may shift to other opportunities with higher returns.read more in Valuation models. The cost of equity derived by the CAPM reflects a reality through which investors have diversified their portfolios to reduce the impact of the systematic riskSystematic RiskSystematic Risk is defined as the risk that is inherent to the entire market or the whole market segment as it affects the economy as a whole and cannot be diversified away and thus is also known as an “undiversifiable risk” or “market risk” or even “volatility risk”.read more. The following are some of the advantages of Beta regression:
  2. It offers an easy-to-use beta calculation in excel, which standardizes a risk measure across multiple firms with varied capital structures and fundamentals.

Disadvantages of Beta Coefficient Regression

The following are some of the disadvantages of Beta regression:

  1. There is a heavy reliance on past returns and does not consider updated information/other factors that can impact the returns in the future.
  2. Beta regression as more return is garnered, the measure of Beta changes, and so will the cost of equity.
  3. Though systematic risks are inherentRisks Are InherentInherent Risk is the probability of a defect in the financial statement due to error, omission or misstatement identified during a financial audit. Such a risk arises because of certain factors which are beyond the internal control of the organization.read more to the market in explaining asset returns, the portion of unsystematic risks is ignored.

Negative Beta

A negative beta formula means an investment that moves in the opposite direction against the stock market. When the market rises, the negative beta tends to fall, and the negative beta will tend to rise when the market falls. It is generally true for gold stocks and gold bullion. Since Gold is a more secure store of value than currency, a crash in the market prompts investors to liquidate their stocks and convert them into currency (for zero betas) or purchase gold in case of a negative beta coefficient.

A negative beta does not highlight that risk is absent, but it means that the investment offers a hedge against an unforeseen market downturn. However, suppose the market continues to rise. In that case, a negative-beta coefficient strategy is losing money through opportunity risk (loss of a specific chance to earn higher returns) and also inflation riskInflation RiskInflation Risk is a situation where the purchasing power drops drastically. It could also be explained as a situation where the prices of goods and services increase more than expected. Inflation Risk is also known as Purchasing Power Risk.read more (rate of return not keeping pace with the prevailing inflation in the country).

Beta Coefficient Video

Frequently Asked Questions (FAQs)

1. What is the relevance of the beta coefficient? 

The beta coefficient is relevant as it measures a stock’s sensitivity to market movements, assessing investment risk. It helps investors understand how a stock’s price may change concerning broader market fluctuations. A beta above 1 indicates higher volatility than the market, while a beta below 1 suggests lower volatility.

2. What are the applications of the beta coefficient? 

The beta coefficient finds various applications in finance and investing. It is a key component in the Capital Asset Pricing Model (CAPM) to determine expected returns on assets. Investors use beta to evaluate a stock’s risk, construct diversified portfolios, and make informed investment decisions based on their risk tolerance.

3. Is the beta coefficient the same as the correlation coefficient? 

No, the beta coefficient and correlation coefficient are different measures. Beta measures the systematic risk of a stock in relation to the market, while correlation measures the degree of linear relationship between two variables. Beta focuses on the stock’s response to market movements, whereas correlation describes the strength and direction of the relationship between two assets.

This article has been a guide to Beta Coefficient, formulas, and calculations. Here we calculate beta in excel of MakeMyTrip using three methods – Variance-Covariance, SLOPE Function, and Regression Function. You may also have a look at these other recommended articles to learn more about valuations –

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