Beta question
As companies mature will their beta move towards one ?
Or is thing being confused with the size premium of a company?
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The levered beta is a measure of how much a company equity (share price) moves up or down compared to the whole market (e.g., if Microsoft has a beta of 1.5, it means that on average if the S&P500 goes up 1%, then Microsoft shares will go up 1.5%).
That being said, the beta of a stock is a result of the industry the company operates in (there are industries that are more volatile than the market and thus have a beta > 1, and industries less volatile than the market than have betas 1) and the leverage of the company (the higher the leverage, the higher the beta).
To answer your question, as a company matures, its ULEVERED beta (this is the beta not taking into account the leverage effect) should move towards the industry beta, which is not necessarily 1. The levered beta (that is the observed beta in the equity markets) will depend also on the level of leverage.
Preface: Still a college student. Take what I say with a grain of salt; it is based on my short education.
I don't understand why the Beta would move closer to 1. Only a company whose revenues and expenses grow at the same rate as the overall economy would have a beta close to 1 (as long as the market was well aware of this correlation). The only potential reasoning I can see is that as companies mature, they begin to diversify their revenues and expenses across different industries, giving them rev/exp that grow in line with the overall economy.
Aside from that reason, I don't think it's unreasonable to imagine a mature company pegged to one sector (say technology) where their Beta would be very high relative to the entire market.
unlevered beta moves closer to 1 (usually to between .8 and 1.2 for mature companies)
What are you talking about? Unlevered beta, or performance relative to the market, should not necessarily converge with 1 over time.
For example, counter cyclical businesses (e.g., post secondary education, gold mining) with a negative beta will not converge to +1. Also, businesses that depend on large capital expenditures (e.g., capital goods manufacturers, homebuilders) will always be more volatile than the market as a whole.
I agree with smuguy, they should converge on their industry betas upon maturity, not the beta of the market as a whole
I think there's some miscommunication here. Smuguy and sa4hire, I don't think the poster meant that the Betas were going to converge to 1 - but merely that a company's beta should move closer to 1 as it matures, which is generally correct. Theory being something to the effect of a company constantly growing, maturing, and diversifying - ever more closely aligning with the "market." I remember this being preached by finance profs back in school, although it seems only applicable in a vaccuum.
My disagreement here stems from the fact that while this may hold for some industries, it most certainly does not hold for all of them.
In particular, no logic holds as to why super-cyclical industries (think heavy capital equipment manufacturers) and counter-cyclical industries (think bankruptcy advisory services) should converge to market performance, as the former will always exhibit "lumpier" performance than the market, while the latter will continue to perform best in times that the overall market does not.
I agree with what you're saying to an extent, but take one of your examples: heavy capital equipment manufacturers. Also, assume it's a young company with a beta around 1.3. As the company matures, you expect for its beta to decrease 1 (say 1.2 or 1.15 - who cares). Point being that you'd expect more volatile companies to become less volatile as they grow and mature, same with industries.
Yes, these companies will always be lumpier or perform better than the market, but the extent of that lumpiness should lessen over time, correct?
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