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CAPM Beta

Updated on May 3, 2024
Article byWallstreetmojo Team
Reviewed byDheeraj Vaidya, CFA, FRM

CAPM Beta is a theoretical measure of the way how a single stock moves with respect to the market, by taking correlation between the both; market represents the unsystematic risk and beta represents the systematic risk.

CAPM Beta When we invest in stock markets, how do we know that stock A is less risky than stock B. Differences can arise due to market capitalization, revenue size, sector, growth, management, etc. Can we find a single measure that tells us which stock is riskier? The answer is YES, and we call this as CAPM Beta or Capital Asset Pricing Model Beta.

In this article, we look at the nuts and bolts of CAPM Beta –

What is the CAPM Beta?

Beta is a very important measure that is used as a key input for Discounted Cash Flow or DCF valuations.

You can download this CAPM Beta Calculation Excel Template here – CAPM Beta Calculation Excel Template

Key Takeaways

  • CAPM Beta is a concept used to gauge how a specific stock moves in relation to the overall market, achieved by assessing its correlation. While the market addresses unsystematic risk, Beta quantifies systematic risk.
  • Stock risks are categorized into two types: non-systematic and systematic. Non-systematic risks can be mitigated through diversification, whereas systematic risks influence the entire market and remain unavoidable. BETA is a vital metric for measuring systematic risk.
  • Investments in gold and international companies might exhibit a negative beta due to their inverse correlation with the stock market and their limited direct ties to the domestic economy.

CAPM Beta Formula

If you have a slightest of the hint regarding DCF, then you would have heard about the Capital Asset Pricing Model (CAPM) that calculates the Cost of Equity as per the below Beta formula.

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

Cost of Equity

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Source: CAPM Beta (wallstreetmojo.com)

If you have not heard of Beta yet, then worry not. This article explains to you about Beta in the most basic way.

Let us take an example: when we invest in stocks, it is but human to pick stocks that have the highest possible returns. However, if one chases only returns, the other corresponding element is missed, i.e., Risk.

Actually, every stock is exposed to two types of risks.

  • Non-Systematic Risks include risks that are specific to a company or industry. This kind of risk can be eliminated through diversification across sectors and companies. The effect of diversification is that the diversifiable risk of various equities can offset each other.
  • Systematic Risks are those risks that affect the overall stock markets. Systematic risks can’t be mitigated through diversification but can be well understood via an important risk measure called “BETA.”
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What is Beta?

Basic Definition of Beta – Beta measures the stock risks in relation to the overall market.

Beta Values

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  • If Beta = 1: If the Beta of the stock is one, then it has the same level of risk as to the stock market. Hence, if the stock market (NASDAQ and NYSE, etc.) rises up by 1%, the stock price will also move up by 1%. If the stock market moves down by 1%, the stock price will also move down by 1%.
  • If Beta > 1: If the Beta of the stock is greater than one, then it implies a higher level of risk and volatility as compared to the stock market. Though the direction of the stock price change will be the same; however, the stock price movements will be rather extremes. For example, assume the Beta of the ABC stock is two, then if the stock market moves up by 1%, the stock price of ABC will move up by two percent (higher returns in the rising market). However, if the stock market moves down by 1%, the stock price of ABC will move down by two percent (thereby signifying higher downside and risk).
  • If Beta >0 and Beta<1: If the Beta of the stock is less than one and greater than zero, it implies the stock prices will move with the overall market; however, the stock prices will remain less risky and volatile. For example, if the beta of the stock XYZ is 0.5, it means if the overall market moves up or down by 1%, XYZ stock price will show an increase or decrease of only 0.5% (less volatile)

In general, large companies with more predictable Financial Statements and profitability will have a lower beta value. For example, Energy, Utilities, and Banks, etc., all tend to have a lower beta. Most betas normally fall between 0.1 and 2.0 though negative and higher numbers are possible.

Key Determinants of Beta

Now that we understood Beta as a measure of Risk, it is important for us to also understand the sources of risks. Beta depends on a lot of factors – usually, the nature of the business, operating and financial leverages, etc.

The below diagram shows the key determinants of Beta –

Beta Determinants

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  • Nature of Business – The beta value for a firm depends on the kind of products and services offered and its relationship with the overall macro-economic environment. Note that Cyclical companies have higher betas than non-cyclical firms. Also, discretionary product firms will have higher betas than firms that sell less discretionary products.
  • Operating leverage: The greater the proportion of fixed costs in the cost structure of the business, the higher the beta
  • Financial leverage: The more debt a firm takes on, the higher the beta will be of the equity in that business. Debt creates a fixed cost, interest expenses that increase exposure to market risks.

High Beta Stocks/Sectors

Due to the uncertain economic environment, questions always remain on what is the best investment strategy. Should I pick high CAPM Beta stocks or Low CAPM Beta Stocks? It is normally understood that cyclical stocks have high Beta and defensive sectors have low Beta.

Cyclical stocks are those whose business performance and stock performance is highly correlated with economic activities. If the economy is in recession, then these stocks exhibit poor results, and thereby stock performance takes a beating. Likewise, if the economy is on a high growth trajectory, cyclical stocks tend to be highly correlated and demonstrate a high growth rate in business and stock performances.

Take, for example, General Motors; its CAPM Beta is 1.43. This implies if the stock market moves up by 5%, then General Motors stock will move up by 5 x 1.43 = 7.15%.

The following sectors can be classified as cyclical sectors and tend to exhibit High Stock Betas.

  • Automobiles Sector
  • Materials Sector
  • Information Technology Sector
  • Consumer Discretionary Sector
  • Industrial Sector
  • Banking Sector

Low Beta Stocks/Sectors

Low Beta is demonstrated by stocks in the defensive sector. Defensive stocks are stocks whose business activities and stock prices are not correlated with economic activities. Even if the economy is in recession, these stocks tend to show stable revenues and stock prices.  For example, PepsiCo, its stock beta is 0.78. If the stock market moves down by 5%, then Pepsico stock will only move down by 0.78×5 = 3.9%.

The following sectors can be classified as defensive sectors and tend to exhibit Low Stock Betas-

  • Consumer Staples
  • Beverages
  • HealthCare
  • Telecom
  • Utilities

CAPM Beta Calculation in Excel

Technically speaking, Beta is a measure of stock price variability in relation to the overall stock market (NYSE, NASDAQ, etc.). Beta is calculated by regressing the percentage change in stock prices versus the percentage change in the overall stock market. CAPM Beta calculation can be done very easily on excel.

Let us calculate the Beta of MakeMyTrip (MMTY) and Market Index as NASDAQ.

Step 1 – Download the Stock Prices & Index Data for the past 3 years. 

The first step is to download the stock price and Index data. For NASDAQ, download the dataset from Yahoo Finance.

NASDAQ Historical Prices Download

Likewise, download the corresponding stock price data for the MakeMyTrip example from here.

Step 2 – Sort the Dates & Adjusted Closing Prices

Once you have downloaded the data set for the two, please do the following for each of the data set-

  • Sort the dates and Adjusted Closing prices in ascending order
  • Delete Open, High, Low, Close & Volume Column. They are not required for Beta Calculations. 
Beta Calculation - Step 2
Step 3 – Prepare a single sheet of Stock Prices Data & Index Data.
Beta Calculation - Step 3
Step 4 – Calculate the Fractional Daily Return
Beta Calculation - Step 4
Step 5 – Calculate Beta – Three Methods

You can use either of the three methods to calculate Beta – 1) Variance/Covariance Method 2) SLOPE Function in excel 3) Data Regression

  • Variance / Covariance Method 
Beta Calculation using Variance Covariance

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

  • SLOPE function in excel 
Beta Calculation using SLOPE Method

Using this SLOPE function method, we again get the Beta as 0.9859 (Beta Coefficient)

  • 3rd Method – Using Data Regression

For using this function in excel, you need to go to the Data Tab and select Data Analysis.Data Analysis

If you are unable to locate Data Analysis in Excel, then you need to install the Analysis ToolPak. This process is relatively easy: Go to FILE -> Options -> Add-Ins -> Analysis ToolPak -> 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

As noted above, you get the same answer of Beta (Beta Coefficient) in each of the methods. 

Also, note that MakeMyTrip beta is approximately closer to 1.0, this implies that MakeMyTrip stock prices have the same level of risk as to the broad NASDAQ Index.

Levered vs. Unlevered Beta

Levered Beta or Equity Beta is the Beta that contains the effect of capital structure, i.e., Debt and Equity both. The beta that we calculated above is the Levered Beta.

Unlevered Beta is the Beta after removing the effects of the capital structure. As seen above, once we remove the financial leverage effect, we will be able to calculate Unlevered Beta.

Unlevered Beta can be calculated using the following formula –

       Beta (Unlevered) = Beta (levered)/ (1+ (1-tax) * (Debt/Equity))

As an example, let us find out the Unlevered Beta for MakeMyTrip.

Debt to Equity Ratio (MakeMyTrip) = 0.27

Tax Rate = 30% (assumed)

Beta (levered) = 0.9859 (from above)

       Beta (Unlevered) = 0.9859 / (1+ (1-30) * 0.27)

       Beta (Unlevered) = 0.8291

Calculate Beta of an Unlisted or Private Company

As seen earlier, Beta is a statistical measure of the variability of a company’s stock price in relation to the stock market overall. However, when we evaluate private companies (not listed), then how we should find Beta? In this case, Beta does not exist; however, we can find an IMPLIED BETA from the comparable companies analysis.

Implied Beta is found using the following 3 step process –

Step 1 – Find all the Listed Comparables whose Beta’s are readily available.

Please note that the Betas that you download are Levered Betas, and hence, it is important to remove the effect of capital structure. The higher amount of debt implies higher variability in earnings (Financial Leverage), which in turn results in higher sensitivity to the stock prices.

Let us assume here that we want to find the Beta of a private company, let’s call this as PRIVATE. As a first step, we find all the listed peers and identify their Betas (levered)

Private Company Beta Competitors
Step 2 – Unlever the Betas 

We will use the formula discussed above to Unlever the Beta.

               Beta (Unlevered) = Beta (levered)/ (1+ (1-tax) * (Debt/Equity))

Please note that for each of the competitors, you will have to find additional information like Debt to Equity and Tax Rates. While unlevering, we will be able to remove the effect of financial leverage.

Private Company Beta Competitors - Unlevered
Step 3: Relever the Beta

We then relever the beta at an optimal capital structure of the PRIVATE company as defined by industry parameters or management expectations. In this case, ABC company is assumed to have a Debt/Equity of 0.25x and a Tax Rate of 30%.

The calculation for the relevered beta is as follows:

Relevered Beta

It is this relevered Beta that is used for calculating the Cost of Equity of the Private companies.

What Does a Negative Beta Mean?

Though in the above cases, we saw that Beta was greater than zero; however, there may be stocks that have negative betas. Theoretically, the negative beta would mean that the stock moves in the opposite direction of the overall stock market. Though these stocks are rate, they do exist. Many companies that are into gold investing can have negative betas because gold and stock markets move in the opposite direction. International companies may also have negative beta as their business may not be directly linked to the domestic economy.

If you are curious to see some examples of Negative Beta Stocks, here is the process through which you can hunt for negative beta stocks.

Step 1 – Visit Yahoo Screener
Yahoo Screener
Step 2 – Choose the Industry Filter

You may choose the sector/industry of your choice. I have picked up Gold (Basic Materials)

Yahoo Screener - Gold
Step 3 – Choose the Beta Values Minimum and Maximum
Yahoo Screener - Choose Beta values
Step 4 – Click on Find Stocks, and you will see the list below
Gold Beta List
Step 5 – Sort the Beta column from Low to High
Negative Beta List

Step 6 – Enjoy the list of Negative Betas :-)

Advantages of CAPM Beta

  • Single measures to provide an understanding of security volatility as compared to the market. This understanding of stock volatility helps the portfolio manager with his decisions of adding or deleting this security from the portfolio.
  • Most of the investors have diversified portfolios from which unsystematic risk has been eliminated. Beta only considers systematic risk, thereby providing the real picture of the risks involved.

Disadvantages of CAPM Beta

  • “Past Performance is no guarantee of future” – This rule also applies on Beta. While we calculate beta, we take into account historical data – 1 year, 2 years or 5 years, etc. Using this historical beta may not hold true in the future.
  • Cannot accurately measure Beta for new Stocks – As we saw from above that we can calculate beta of unlisted or private companies. However, the problem lies in finding the true comparable that can provide us with an implied Beta number. Unfortunately, we do not always have the right comparable for start-ups or private companies.
  • Beta does not tell us whether the stock was more volatile during the bear phase or the bull phase. It does not distinguish between upswings or downswing movements.

CAPM Beta Video

Frequently Asked Questions (FAQs)

1. What is the relevance of CAPM Beta?

CAPM Beta’s relevance lies in its ability to quantify an asset’s systematic risk, indicating how much it tends to move in relation to the overall market. It aids investors in assessing an asset’s sensitivity to market fluctuations, allowing for more informed investment decisions and portfolio diversification strategies.

2. What are the applications of CAPM Beta?

Applications of CAPM Beta include evaluating an asset’s risk and expected return, estimating the cost of equity for valuation purposes, constructing well-balanced portfolios, and comparing assets based on their risk exposure to the market.

3. What are the assumptions of CAPM Beta?

Assumptions of CAPM Beta include efficient markets, where all relevant information is reflected in prices; investors share the same expectations; no transaction costs or taxes; a risk-free asset is available; unlimited borrowing and lending at the risk-free rate; and a single-period investment horizon. Additionally, Beta assumes that asset returns follow a linear relationship with the market and that asset-specific risks are diversifiable, leaving only systematic risk relevant for pricing.

  1. Beta Formula
  2. Stock Beta Meaning
  3. Sum of Parts Valuation

What next?

If you learned something new or enjoyed the post, please leave a comment below. Let me know what you think. Many thanks, and take care. Happy Learning!

Reader Interactions

Comments

  1. Lade says

    This is the best material for Financial management.

  2. RR says

    Thanks, well explained and written making it interesting to read

  3. Courage Hodey says

    I have enjoyed every bit of the lesson here.
    This is very insightful and beginners can rely heavily on the lessons for a full grasp of the concept.

  4. Meharsh Bajaj says

    Amazing!

  5. Rupali Joshi says

    Amazing artical, all the related points which one can think of beta are just clearly explained.

    much helpful.

  6. Silky Kushwah says

    quite interesting!

    Enjoyed reading..

    Thanks

    • Dheeraj Vaidya says

      Thanks for your kind words!

  7. Hannan says

    Great article. It helped me calculate WACC for the private company I work for.

  8. Thuy says

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    • Dheeraj Vaidya says

      Thanks for your kind words!

  9. vero says

    I LOVE YOUR ARTICLES VERY KNOWLEDGEABLE AND INFORMATIVE

  10. Kenei says

    You are a rockstar! Thank for sharing.

  11. Kenei says

    You are a rockstar! Thanks for sharing.

  12. Vijay kumar pathak says

    You are really doing a very amazing work by publishing and sharing such a informative articles..I always eagerly wait for your every next article..
    Thank you..

  13. Francisco Coca says

    Thanks for your help!!!

  14. Charles says

    Thanks a lot colleagues

  15. Kirandeep Kaur says

    This is by far the best post of explaining “Beta” in so much detail and that too with easy examples. Always enjoy learning here!

  16. Andrew says

    Excellent article, as usual!

  17. Navraj says

    Its very helpful !!

    Thanks for the knowledge sharing …

  18. Prithvi says

    Very informative, thank you very much for the explanation.

    • Dheeraj Vaidya says

      thanks Prithvi!

  19. Jamie says

    Clear and concise explanation of Beta. Thank you :)

  20. VENKATESH says

    well explained in simple steps. very informative.

      • Issifu says

        Clarity is your trump card. You have helped me greatly.
        Thank you.
        Issifu.

  21. S.Shankar says

    it is great article I understood concept of levering and unlevering Beta easily. Thanks

  22. Mahmoud says

    many thanks! you make it very clear

    • Dheeraj Vaidya says

      My Pleasure Mahmoud!

  23. Sachin Gupta says

    Hi Dheeraj,

    This article is very helpful and the most amazing thing is the way of describing the concept of beta.

    Thnks a lot

  24. Akanksha Agrawal says

    Thanks Dheeraj Sir.Your way of explanation is Awesome.
    Helped me alot thanks very much.

  25. Jithin says

    Thank you so much for the article and the worksheet. Helped a lot to understand. Keep on writing.

    • Dheeraj says

      thanks Jithin!

  26. Gabriel says

    Great, very informative.Thank you!

  27. Terry says

    It’s a great essay to understand the Beta. Now I get the approaches to calculate beta from stock market.
    Thank you so much!
    But I have a question about beta:Suppose a statement said a corp. carried $200 million debt and has 15 million shares trading at price of $30 in TSX. It’s stock beta is 0.9. This beta is levered beta or unlevered beta?Thanks!

    Terry

    • Dheeraj says

      Hi Terry,

      The stock beta that is mentioned in bloomberg and other databases is levered beta (includes the effect of debt). If you want to calculated the unlevered beta from this, then you need to apply the formula to unlever the same.

      Thanks,
      Dheeraj

  28. Ali says

    You are soooooooooo gooood

    • Dheeraj says

      thanks Ali!

  29. MARIA SHUJA says

    thank sir u really make it easy…

    • Dheeraj says

      thanks Maria!

  30. Kola Yaqub says

    Thanks for sharing the wonderful knowledge. It is very informative and explanatory.

    I like appreciate more education on other seemingly confusing areas in finance such as fixed income, derivatives and asset beta.

    Thank you once again

    • Dheeraj says

      Hello Kola,

      Many thanks for your appreciation :-)

      Best,
      Dheeraj

  31. Gaurav verma says

    Awesome brother you are doing good work. This article is very very helpful to me and many others.

    • Dheeraj says

      thank you Gaurav!

  32. Herman Tan says

    This is great Dheeraj.
    It is very clear explanation.

    • Dheeraj says

      thank you Herman :-)

  33. Vitali says

    great, Dheeraj

    • Dheeraj says

      Thank you Vitali!

  34. NIrupam Naudiyal says

    HI Dheeraj Sir,

    This is the first finance related blog that i have ever seen in my whole life which describes the complicated things with such an ease and this is really unforgettable. I am very much inspired and impressed by you and would like to work with the same dedication or more to help people in a such a great manner. Please provide your personal mail id or contact no. (if possible)so that i can connect with you and can connect with you.

    Thanks & Regards
    Nirupam Naudiyal

  35. haytham says

    thank you…I owe to you

  36. Berenice says

    Very didatic article. Thanks and congratulations!

    • Dheeraj says

      Thanks Berenice!

  37. vincent says

    I like the way you have explained finance concepts, its clear and enjoyable. Also thanks for sharing your knowledge and some data here :)

  38. Nadine says

    This is comprehensive, simple to understand and awesome! Thanks sooo much!

  39. Huron says

    Very clear explanation. Thanks!

  40. Somsubhra Mukherjee says

    Simple and very welled explained…Can you please upload module on FOREX.

    • Dheeraj says

      Thanks Somsubhra. I am looking forward to an article on Forex in the near future.

  41. msdevi says

    well explained in a simple way.

  42. Manohar says

    You explained in very lucid and simple language . Looking forward for more posts on security valuation.
    Thanks

  43. Ankit says

    Sir, request you to take some important FM concepts on a regular basis like minority interest and adjustments and other such important but often ignored concepts.
    Thanks.

  44. Ankit says

    it was a great article in a way that though i learnt beta concepts during my MBA, but it was not this thorough and practical in approach. and yahoo screener was a new thing as well.

  45. sandheep says

    Your articles are always simple and interesting.
    Thank you

  46. AVGRAO says

    Sir,Ur article is excellent. Without abc knowledge in FM, this articles creates LOVE in FM. With regards

    • AVGRAO says

      excellent Sir, with regards

  47. mahendra edunoori says

    its a very important article. and i learned new things with your article. i glad to thanks to you….

  48. Neeraj says

    Your article always have new things for me to learn from

  49. Anika Kalra says

    I thought negative beta stocks are difficult to find. Your article is very comprehensive. Thanks Dheeraj

    • Wall Street Mojo says

      Thanks Anika!

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