If you’ve ever built a DCF or tried to calculate WACC, you’ve encountered beta—usually sitting quietly inside the Capital Asset Pricing Model (CAPM) formula.
But what is beta, really? And why does this one number influence how expensive a company’s equity is?
At its core, beta measures how sensitive a stock is to market movements. It helps investors understand risk—and more importantly, how much return they should demand for taking that risk. That return becomes the cost of equity, a critical input in valuation.
In this article, we’ll explain what beta represents, how it’s calculated, how it’s used in practice, and why it matters so much in determining value.
What Is Beta?
Beta is a measure of systematic risk—the kind of risk you can’t diversify away. It tells you how much a stock tends to move in relation to the overall market.
If the market goes up by 1%, and a stock goes up by 1.2%, that stock has a beta of 1.2. It’s more volatile than the market.
If it only goes up 0.8%, the beta is 0.8—less volatile.
If it moves in the opposite direction, the beta is negative.
In short:
- Beta = 1.0 → same volatility as the market
- Beta > 1.0 → more volatile than the market
- Beta < 1.0 → less volatile than the market
- Negative beta → moves opposite to the market (rare)
How Beta Affects the Cost of Equity
Beta is a core part of the CAPM formula, which estimates the return that equity investors expect for bearing risk:
Cost of Equity (Re) = Risk-Free Rate + Beta × Market Risk Premium
- The risk-free rate is what investors could earn with zero risk (e.g. a long-term government bond).
- The market risk premium is the extra return required for investing in equities over risk-free assets.
- Beta adjusts that premium based on the company’s risk level.
So a higher beta means a higher cost of equity—because investors demand more return for taking on more volatility.
Where Beta Comes From
Beta is usually estimated by regressing a company’s stock returns against the overall market (often the S&P 500 or a relevant index). Many platforms like Bloomberg, FactSet, or Yahoo Finance report beta directly.
But for private companies or when comparing across sectors, analysts often calculate beta manually based on comparable companies.
Unlevered vs. Levered Beta
A company’s beta reflects both its business risk and its capital structure. That’s why we often unlever beta to isolate just the business risk—and relever it to reflect the target company’s debt profile.
Here’s how:
Unlevered Beta:
Unlevered Beta = Levered Beta / [1 + (1 – Tax Rate) × (Debt / Equity)]
Relevered Beta:
Relevered Beta = Unlevered Beta × [1 + (1 – Tax Rate) × (Debt / Equity)]
This is especially useful in DCFs, where you want to estimate the appropriate beta for the target capital structure—not just what a peer is doing.
How to Use Beta in Practice
- In DCFs, beta determines the cost of equity, which feeds into WACC, which drives valuation.
- In LBOs or strategic modeling, beta helps benchmark risk profiles when comparing public comps.
- In portfolio theory, beta explains how adding an asset affects overall risk.
The key: beta is not about company performance. It’s about volatility and investor expectations. A high-growth company might have a low beta if its stock is stable. A slow-growing one can have a high beta if it swings with the market.
Closing Thoughts
Beta may seem like a small input in the cost of equity formula—but it carries a big message:
How risky is this business in the eyes of investors?
It connects valuation to capital markets. It translates volatility into required return. And it reminds us that value is never just about cash flows—it’s also about the risk of earning them.
Used properly, beta helps ground your WACC in market logic. Misused, it distorts your entire model. That’s why understanding where beta comes from, how to adjust it, and how it behaves across sectors is essential for serious valuation work.