Hi & A Grand welcome back to http://www.Indianequities.

in,
In this post I am going to cover about beta of firm and the reason why it should be
calculated and how it should be computed.
Let me start with the question what is beta and why it is needed? Beta in general
is a variable which holds the firms volatility with respect to the market. For calculating the
returns of a particular asset using Capital Asset Price Model (CAPM) we need a beta to find out
how the volatility factor affects the premium. With a high beta we get a high premium and vice
versa.
How to calculate beta?
As previously mentioned beta should be calculated for a firm against to the
market. In a simple sense how the company is performing against the market. There are different
ways of calculating beta and different types of beta. Let me restrict myself by calculating a
regression beta and a fundamental beta in this post and show you how to lever and unlever a
beta.
Historical Beta Calculation
For calculating beta, HUL (Hindustan Unilever) has been considered. Its (HUL)
historic monthly data has been collected from August 2010 to August 2015 along with BSE 500
data for the same period as shown in the below figure.

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Scatter plot for HUL as dependent and BSE 500 as independent variable can be find in the below
figure

For calculating regression in excel, we use data analysis tool pack. Where dependent
variable is HUL stock and independent variable is BSE 500. The reason for choosing BSE 500
is, it has large market capital stocks when compared to other indices. Regression calculation has
been done as shown below

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And regressions results are shown below

So far so good, Now how to interpret this results? Under Regression Statistics in the
above mentioned figure, R2 variable says about, how much percentage of risk the company
receives from the market. In this case (HUL firm) receives 6.6% of risk from the market this
implies that 93.4% of risk is firm specific. When coming to beta it is 0.34 with standard error of
0.16 with 95% confidence. So, the above stated beta has been calculated from historical data.
The same beta ie., firm volatility can be calculated using fundamentals as shown below.
Fundamental Beta Calculation
Beta determination can be done by the fundamental decisions that firm made such
as, in which business the firm is operating (Cyclical or Non cyclical)? What is the operating
leverage of the firm? On how much amount of financial leverage the firm is operating on? These
questions are answered as below

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Type of firms business?

How big or small the firm is,
is the beta depends on the products which consumers
feels discretionary ie., irrespective of financial condition the firm should be able to sell it
products or services to the consumer. If the firm can do it then it is called non cyclical firm else it
would be cyclical. So if it is a cyclic
cyclical
al firm and products are considered to be discretionary the
beta will be high. As market is pitching these product will go smoothly (sold
sold out
out) in the market
else there will be fluctuations in their sales. If it is a non cyclical firm the beta will be less than
one.
How operating leverage effects the firm? And how to calculate operating leverage?
Operating leverage calculates the ratio of fixed costs to that of total costs
costs, as fixed
costs should be bared, irrespective of sales,
sales this ratio says how much the firm should spend
sp
even
if there are no sales. The increase operating leverage increases the beta of the firm and vice versa
but how to calculate operating leverage for a public traded company. It is known that there will
be no split on operational
al expenses such as fixed costs and variable costs so how to find them.
The work around for this issue is to use % change in EBIT (Earnings before interest and taxes) to
that of % change in net sales.. The rationale here is % change in net sale capture the variable cost
that is involved in making the good as fixed costs are constant. So,

For HUL, the operating leverage is equal to 1.47 for the period of 2004 to 2015 and below
figure shows the data used for the same period.
period

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Operating leverage is an unlevered beta this should levered using financial leverage for finding
out financial leverage we use debt to equity ratio as shown below.

For India marginal tax rate is 30% (marginal tax rate is the tax rate on the last rupee earned). So,
levered beta is

Data for calculating average debt/equity is shown below

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So, the above post helps in finding out why beta is required and how we can estimate beta
of a firm with various parameters. Hope you have understood it.
Regards
Ravi Teja
http://www.indianequities.in

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