It is better to use an unlevered beta over a levered beta when a company or investor wishes to measure a publicly-traded security’s performance in relation to market movements without the effects of that company’s debt factor.
Positive and Negative Levered Betas
A publicly traded security’s levered beta measures the sensitivity of that security’s tendency to perform in relation to the overall market. The levered beta includes a company’s debt in the calculation of its sensitivity. Security with positive levered beta signals that the security has a positive correlation with market performance and security with negative levered beta signals that the security has a negative correlation with market performance.
A levered beta greater than positive 1 or less than negative 1 means that it has greater volatility than the market. A levered beta between negative 1 and positive 1 has less volatility than the market.
Unlevered Beta and Accuracy
In relation to levered beta, a security’s unlevered beta has a value closer to zero; it has less volatility due to the tax advantages of debt.
A security’s unlevered beta also measures that security’s volatility and performance in relation to the overall market, but it takes out the effects of a company’s debt factors. Since a security’s unlevered beta is naturally lower than its levered beta due to its debt, its unlevered beta is more accurate in measuring its volatility and performance in relation to the overall market.
Calculating a security’s unlevered beta gives potential investors valuable insight into the performance of that security when compared to the market. If a security’s unlevered beta is positive, investors want to invest in it during bull markets. If a security’s unlevered beta is negative, investors want to invest in it during bear markets.
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