P/B ratio

Abstract: This paper interprets the price-earnings ratio (PIE) and the marketto-book ratio (PIB) and describes how they articulate. It also describes the role of book rate-of-return on equity (the ratio of their denominators) in the determination of the ratios and the relation between them. Although both are reported regularly, there is not a common understanding of these issues. For example, the PIE ratio has been interpreted as an earnings growth indicator (Cragg and Malkiel [1982] and Litzenberger and Rao [1971]), a risk measure (Ball [1978]), and an earnings capitalization rate (Graham, Dodd, and Cottle [1962], Boatsman and Baskin [1981], and Alford [1992]). Derivations based on the Gordon [1962] model describe it as determined by return on equity. Beaver and Morse [1978] show that this ratio indicates transitory earnings (the "Molodovsky effect" from Molodovsky [1953]). It has also been interpreted as an indicator of mispriced stocks (Basu [1977] and Jaffee, Keim, and Westerfield [1989]) and as a product of accounting principles (Craig, Johnson, and Joy [1987]). The P/B ratio received less academic attention until Fama and French [1992]. Traditionally, it was interpreted as indicating expected return on equity (see, for example, Graham, Dodd, and Cottle [1962]). This interpretation is given expression in the standard formula reconciling price to book value (in Preinreich [1938], Edwards and Bell [1961], and Peasnell [1982], for example). Like PIE, P/B has been modeled as a growth

Abstract: In this paper, we distinguish two sources of variation in the book-to- market ratio-bias and lags in book value (hereafter, bias and lags) -with different implications for the book-to-market ratio's ability to predict future book return on equity. Specifically, we hypothesize and find that the bias component of the book-to-market ratio has a more persistent cross-sectional association with future book return on equity than does the lag component. This investigation is motivated both by the central role of expectations of book return on equity in the discounted residual in- come valuation model (e.g., see Feltham and Ohlson (1995)) and by prior empirical research that finds that the book-to-market ratio is correlated with future book return on equity (e.g., see Fama and French (1992; 1995), Penman (1992), and Bernard (1994)).

Abstract: Fama and French (1992) document a significant relation between firm size, book-to-market ratios, and security returns for nonfinancial firms Because of their initial interest in leverage as an explanatory variable for security returns, Fama and French exclude from their analysis financial firms, thus creating a natural holdout sample on which to test the robustness of their results We document that the relation between firm size, book-to-market ratios, and security returns is similar for financial and nonfinancial firms In addition, we present evidence that survivorship bias does not significantly affect the estimated size or book-to-market premiums in returns Our results indicate data-snooping and selection biases do not explain the size and book-to-market patterns in returns

Abstract: This paper documents a strong link between firm level total factor productivity (TFP) and several firm characteristics that are known to predict future stock returns, such as size, the book to market ratio, investment, and hiring rate. TFP is positively related to contemporaneous stock returns and negatively related to future excess returns and ex-ante discount rates. Low productivity firms on average earn a 6% annual premium over high productivity firms in the following year and the premium is countercyclical. We interpret the spread in the average returns across these portfolios as the risk premia associated with the higher risk of low productivity firrms. A production-based asset pricing model with aggregate and idiosyncratic shocks accounts for most of these stylized facts.