Beta is the amount of volatility of a certain security compared to its benchmark index. For stocks, this index is usually the Standard and Poors 500. A perfect correlation would have a beta of 1, no correlation would have a beta of 0 and a perfect negative correlation would have a beta of -1. Beta is an important risk metric to help investors understand the downside potential for their investments.
Download or gather the closing prices of the particular stock that you are seeking to evaluate. Do the same for the S&P 500 prices during the exact same period that you are examining.
Calculate the return over the period that you are examining. The simple way to determine the return is to subtract the original closing price from the newest closing price and divide by the original price. So if a stock has a starting price of $10 and ends the period at $12, it is a 20 percent increase. Similarly, if the S&P starts at 1,100 and ends at 1,298, it has a 18 percent increase -- (12-10)/10 = 0.2, (1298-1100)/1100 = 0.18.
Find the risk-free rate of return for the market. This is usually defined as the interest rate for long-term U.S. Treasury bonds. Use a 4 percent interest rate in this example.
Use the Capital Asset Pricing Model (CAPM) to solve for Beta. The formula is as follows:
Re = Rf + B(Rm - Rf)
Where Re is the Return of equity (on your particular stock), B is Beta, Rf is the risk free rate and Rm is the market rate (or S&P 500 rate).
Plug in the numbers and solve for Beta using the numbers from the scenario above,
Re = Rf + B(Rm - Rf) .2 = .04 + B(.18 - .04) B = 1.14
Beta is 1.14
- Thinkstock/Comstock/Getty Images