IBD Interview Question: how to value a company with negative beta?
Got this question on my superday: how to value a company with negative beta? Totally bs my answer during the interview, would like to know the right explanation to this question.
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Not a seasoned pro here, but my first thought when given this question would be to explain the definition of beta.
Loosely speaking, a company's beta is a reflection of the volatility of its return with respect to the market, depending on the magnitude of the beta, a negative beta means that for every basis point the market index gains, the company would lose an x amount.
Off the top of my head, this would mean that perhaps market-based valuation methods would be slightly inappropriate. Of course, this is assuming that your peers are not of negative beta as well (which in any case, I believe is uncommon, but I agree that there are points for contention given that companies in similar industries should have similar returns etc.).
With this in mind, it would be better to use intrinsic valuation methods such as DCF which is not market dependent, which is what beta is essentially. Problem for this is when it comes to the calculation of the cost of equity component of WACC, it might bring up slightly unorthodox numbers but I believe it would still be somewhat sensible.
Happy to hear other thoughts or be corrected if I'm wrong.
Two approaches I can think of 1) take a different time scale and see if it's a different result. If you are using two or three year weekly beta try one year or five year.
If that doesn't work move to step 2) find the asset beta of comparables by unlevering betas using the capital structure. Relever the median or average asset beta to the target capital structure and proceed as normal.
Agreed with approach, though I was thinking of answer from a different point of view
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