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3/30/2014 Finding Beta of an Unlisted Stock...

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Understanding Valuation >
Finding Beta of an Unlisted Stock...
posted Jul 27, 2010, 2:46 AM by Pitabas Mohanty [ updated Jul 27, 2010, 4:39 AM ]
Whether it is a listed or unlisted stock, use the industry beta, if you can find it. While
choosing other listed companies from the same industry, make sure that the unlisted
company is as similar to the listed companies as possible (in terms of the product portfolio,
leverage, profit margin, geographical presence and size). Do not compare a cement company
with another company producing both cement and steel. Once you identify similar listed
companies (pure-plays) from the same industry, find the median beta and use this beta for
the unlisted company. (I will post separately on how to find pure-plays).
Secondly, since the different companies in an industry will have different debt-to-equity
ratio, first estimate the median beta of the industry and using the actual debt-to-equity
ratio of the company, find its levered beta. We normally use the Hamada equation to
estimate the unlevered beta. We also assume the beta of debt to be 0 while unlevering the
beta.
The above equation, also known as Hamada equation, establishes the relationship between
unlevered and levered beta. Suppose, we identify five companies as pure-play for the
company for which we estimate the beta. Using the standard OLS regression, we first
estimate the levered beta. Then by using the above Hamada equation, we estimate the
unlevered beta.
Once we get the unlevered beta of all the pure-plays, we can use the median beta of the
pure-plays as the unlevered beta of the company. Since it is an unlisted company, its debt-
equity ratio (estimated by using the market values) will not be available. This problem can be
avoided by using the multiplier method to get a proxy for the market value of debt. Thus for
example, if the unlisted company reported net income of Rs.500 million, and the median PE
ratio in the industry is 20, then we can estimate its imputed equity value as 20 times Rs.500
million, or Rs.1000 crores.
Let's take an example:
In the above figure, I show the levered beta (column C) of a few software companies. Then
using the respective tax rate and the DE ratio, I show the unlevered beta (with the
assumption that the debt-beta is 0) in the last column. The median unlevered beta is 0.72. I
will use 0.72 as the beta of all the software companies including the above ten companies.
Now, suppose the imputed market debt-equity ratio of the unlisted software company is 0.3.
And suppose the marginal tax rate is 34%. Then the implied levered beta will be: 0.72*
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3/30/2014 Finding Beta of an Unlisted Stock... - Prof Mohanty
https://sites.google.com/a/xlri.ac.in/profmohanty/understanding-valuation/findingbetaofanunlistedstock 2/2
And suppose the marginal tax rate is 34%. Then the implied levered beta will be: 0.72*
(1+0.66*0.3), that is, 0.86.
If the industry beta is not available, use beta of similar companies trading elsewhere in the
world. If you want to find the beta of a travel operator in India and you do not find any
similarly listed company in India, see if similar companies trade in other emerging markets
like China, Thailand.
You can also guess the beta of a company from the nature of its business. Remember that
beta is a measure of systematic risk for a stock. So find out how sensitive is the company to
the ups and downs of the economy. Lets say you want to find the beta of a five-star hotel.
Its performance will be highly correlated with that of the economy. When the economy does
well, the five start hotel will do much better. You cannot build five-star hotels overnight. So
when the demand for rooms surge, the five-star hotels can increase the room tariff and
generate lots of profit. When the economy faces a downturn, they do worse than the
economy. So their beta will be larger than 1. If you are trying to find the beta of a budget
hotel (or a standard hotel like Ginger), its beta will be a little lower than 1. Beta of Saravana
Bhawan will be much lower than 1. Beta of ClearTrips.com will be closer to 1 (may be a bit
higher than 1).
I personally find the last approach the most intuitive. Even if a stock is listed, regressing
stock returns on the market index returns always does not give the right beta. There may be
illiquidity problems. If by regressing Tata Motorss returns on Sensex returns, I get a beta of
0.6, I would rather go by intuition than by the regression output. The performance of a
company producing trucks and passenger cars will be closely linked to Indian economy. Its
beta will be higher than 1. Not 0.6.
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