Ravis Bits of Learning on Beta!!

The analysis of beta values has been done for 5 year period preceding Dec07 i.e. from Jan03 to Dec07. The sensex rose over the five year period from 1179 to 8592. The scrips under discussion have also increased in value, however, at a different pace. The data analysis for the scrips in the question have been done considering 1 year daily stock returns and 5 year weekly stock returns. The 5 year data compilation has an advantage of longer period of data availability and therefore evens out any risk profile change of the company. The daily data of 1 year is more representative in terms of current risk profile of the company but has non-trading biases. 1. The variation in beta values of the companies based on 1 year daily average and 5 year weekly returns is on account of: a. Jet Airways went in for a massive acquisition of assets in year 2007 wherein its debt doubled increasing the financial leverage of the company. The interest payout of the company in 2007-08 was Rs. 496 Crs against average Rs. 250 Crs earlier. Debt equity ratio increased to 6.49 (2007) against earlier year 2.28 and less. The increased financial leverage of the company reflected in the increased beta of the company for one year period as compared to the earlier 5 year period. b. Hindustan Unilever- The company had high debt in year 2003 and 2004. However, after hiving off the debt the debt equity ratio of 0.7 (2004) & 0.8 (2003) dropped down to 0.02-0.03 level. The decreased financial leverage reflected in stabilisation of the companys stock and thereby decreased beta. c. NALCO- The company had some debt in 2003 which it paid off. For the subsequent analysis period the company was a zero debt company implying a financial leverage of 1. Further the company has a low operating leverage which corroborates its stability of stocks indicated by low beta value. Also the 2007 beta value is lower as the 2003-2007 beta had a part impact of the debt the company was carrying in 2003. d. Indian Hotels Limited- The company had a stable financial and operating leverage over the period. The comparative high beta value of the company is on account of the high operating leverage the Hotels have on account of their heavy investment in fixed assests. e. Linc Pens and plastics limited- The more or less stable financial and operating leverage over the period results in very slight variation in the beta of the company over the five year and one year period. f. Hindalco- The high beta value of the company is on account of the high business risk the company has on account of its global operations. The stock of the company was split in Aug2005 from a FV of Rs. 10 to Rs. 1. The companys scrip has been steadily growing in line with the Sensex. The variations in the year 2007 have been more volatile than the sensex which has lead to a high beta value of 1.21. On the 5 year basis the returns smoothen out and show a more steady long term beta value of 0.96.

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Ashish Bhushan 26NMP17

Sensex 10000 9000 8000 7000 6000 5000 4000 3000 2000 1000 0 1/Jan/03

Hindalco 300 250 200 150 100 50 0

1/Jan/04

1/Jan/05

1/Jan/06

1/Jan/07

2. NALCO was a zero debt company from 2004 onwards implying a financial leverage of 1. Further the company has a low operating leverage of around 1.25 which explains the stability of stocks indicated by low beta value. Also the 2007 beta value is lower as the 20032007 beta had a part impact of the debt the company was carrying in 2003. Further the company operates in a closed domestic environment reducing its business risk. 3. The beta represents the systematic risk which is the market risk. The beta basically reflects the traders perception of the relative risk the investment in the company carries with respect to the share market. The trader perceives the risk of the investment looking at the probability of the returns the company is expected to yield which in turn is linked to the operating leverage, financial leverage and business risk of the company. A high operating leverage indicates that in the event of slight change in sales, the companys profits will vary to a great extent. A high financial leverage indicates the high level of interest payment and debt the company is in which makes the venture riskier. The business risk is a risk associated with the type of business the company is carrying out and the same may be industry based or geographical boundary of operation based. 4. The Expected return = Risk free rate + beta x Difference of Market and risk free return (ie Market premium) Ie. Expected Return = 7.9% + beta x (5.7%) a. b. c. d. e. f. Jet Airways: 12.802% Hindustan Uniliver: 11.434% Hindalco: 14.797% NALCO: 8.071% Linc Pens & Plastics: 10.693% Indian Hotels: 12.973%

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Ashish Bhushan 26NMP17