Beta is the measurement of expected return between a stock and the market. Normally we assume that the past is going to represent the future and therefore historical betas are calculated using only historical returns volatility. This practice is widely used in calculating beta, often through a time-series regression analysis comparing the stock’s return with the market’s return.
Conversely, a fundamental beta (also know as predicted beta) is derived from current and predicted fundamentals of the company. Different models incorporate various risk factors, such as company size, volatility, momentum, and other value factors, in calculating a company’s fundamental beta. Northfield recalculates the fundamental beta monthly, thereby taking into account any changes in the company’s underlying risk structure during that time.
Adjusted Beta in Bloomberg is based on historical data, but is an estimate of a security's future beta. It is modified by the assumption that a security's beat moves toward the market average over time.
For exam
ple, Target's historical beta is a very low .60.
However, its adjusted beta is .79
Professionals and academics alike argue that there are several problems with using historical betas. Two major complaints of a historical beta are that it:
· Is influenced by one-time events that are unlikely to affect a company again, thereby artificially depressing or raising a company’s beta.
The decision to use a historical or fundamental beta is up to the individual performing the analysis. However, many studies have demonstrated that fundamental betas significantly outperform historical betas as predictors of future stock behavior.
(Reference: Barra Beta Books for Companies, http://alacra.com/partners)