Levered beta is a measurement of an asset's tendency to move with or against the market as a whole. These values are used as a means of estimating an asset’s actions given a certain type of market. When an asset runs contrary to market, it is better to invest when the market is poor. On the other hand, an asset that runs with the market is good to invest in when the market is up. The levered part refers to the means by which the beta is calculated and is distinct from an unlevered beta.
The most common places to find levered beta values are in the stock market. These values are used by investors to determine the overall risk of an investment as compared to the current market trends. The basic stock market, typically defined by a major stock market index, is set at one. All other betas revolve around that base number. This means that from period to period, a beta may change but the defining index never does.
The term levered beta is made up of two terms. The beta half is the actual measurement of stock tendency, while the levered half refers to how the beta is derived. In general, beta is the more important aspect of the two, but knowing the derivation method allows for a more informed decision by the investor.
A levered beta is a positive number, negative number or a zero. A positive beta shows that the asset’s value improves with the market, and a negative number shows that it improves when the market devalues. The further away from zero the number, the stronger the tendency. While there is no upper or lower limit on betas, a three or four, regardless of whether it is positive or negative, it generally about as high as it goes. A zero indicates that the asset’s value has no correlation at all to the associated market.
Levered means that the beta takes into account any debt associated with the asset. In general, this makes the final beta number closer to zero than an unlevered beta, as the debt will often provide tax advantages to an asset. As such, it is more common to use levered data when possible, as the final number is likely truer to reality.
Stocks that are considered necessities often have a levered beta very close to zero. The fact that people need the products in order to maintain a standard of living means that, regardless of market activity, people will buy them anyway. Companies in this category often make goods such as soap, medicine or alcohol.
