Beta coefficient

What it means

The beta coefficient measures how sensitively the return of a share, company or sector responds to movements of the whole market. A beta of 1 means it moves with the market; a beta of 1.5 means that when the market rises 10 % it rises 15 % on average and falls further when the market drops.

Beta expresses systematic risk, the kind that cannot be diversified away, such as sensitivity to the business cycle or interest rates. Defensive sectors like food or utilities have lower betas, cyclical ones like construction or technology higher.

Beta is a key input to the CAPM, which is used to estimate the cost of equity. A higher beta means a higher required return and a lower company value for the same cash flows.

How it works in practice

When valuing an unlisted business, beta is derived from comparable listed companies in the sector. Their betas are unlevered to remove the effect of debt and then relevered for the target's capital structure.

The resulting beta feeds into the WACC, used to discount cash flows in a DCF valuation. The difference between a beta of 0.8 and 1.2 can change company value by tens of percent.

For small Slovak companies, size and specific risk premiums are usually added to the cost of capital, because foreign comparables' betas alone do not capture their risk.

What to watch out for

Beta is calculated from historical data and depends on the period and frequency chosen. Different sources therefore give different values for the same sector, and the choice should be justified in an expert valuation.

Beta does not measure a company's total risk, such as dependence on one customer or a key person. Those risks must be reflected another way, or the valuation will be too optimistic.