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What is Unlevered Beta?

What is Unlevered Beta?

Unlevered beta measures the Beta (a volatility indicator that denotes how closely an investment follows movements in the market as a whole) of a company when the effects of debt (leverage) are removed, allowing investors to gauge risk strictly as a function of company assets.

The beta of a company’s equity stock is a measure of volatility relative to the rest of the market, impacting Price-to-Earnings (P/E) calculations and other valuations. When beta increases, the cost of equity increases, and results in a higher P/E. Unlevering the beta can give a clearer picture of the market risk of a company’s equity shares, as higher debt relative to equity usually constitutes more risk to investors.

Operating leverage is a measure of how critical each sale of a company is to overall cash flow. It is used by corporations to raise capital without issuing more shares of stock, and it can have some tax benefits. If a company has high operating leverage, it means that it relies on fewer sales with very high gross margins, versus a company with low operating leverage that experiences higher levels of sales with lower gross margins. Taking on leverage usually means issuing bonds, and company earnings are first dispersed to the bondholders.

Unlevered beta is typically lower than or equal to levered beta; if the figure is positive, investors will look to capitalize by investing when stock prices are likely to rise, while a negative unlevered beta will usually see investors engage when stock prices may decline.

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Keywords: leverage, bonds, debt, Beta, market risk, P/E ratio,