Aswath Damodaran 145
Bottom-up versus Top-down Beta
! The top-down beta for a firm comes from a regression
! The bottom up beta can be estimated by doing the following:
- Find out the businesses that a firm operates in
- Find the unlevered betas of other firms in these businesses
- Take a weighted (by sales or operating income) average of these unlevered betas
- Lever up using the firm’s debt/equity ratio
! The bottom up beta will give you a better estimate of the true beta when
- the standard error of the beta from the regression is high (and) the beta for a firm is
very different from the average for the business
- the firm has reorganized or restructured itself substantially during the period of the
regression
- when a firm is not traded
Bottom-up betas build up to the beta from the fundamentals, rather than trusting
the regression.
The standard error of an average beta for a sector, is smaller by a factor of !n,
where n is the number of firms in the sector. Thus, if there are 25 firms in a
sector, the standard error of the average is 1/5 the average standard error.
