Scientific Research

Is There Still Value in the Book-to-Market Ratio?

Scientific Research

Both of these variables produce more return dispersion than E/P and CF/P, even during the period when BtM is supposed to be less relevant (Figure 5). Unfortunately for investors in value stocks, the return difference went the wrong way during the most recent twelve-year period. Some have argued that the effects of the new economy are most pronounced during the most recent five years, and this is the period when book value ceased to be relevant. Figure 6 shows the average annual return differences for this period. If anything, BtM worked too well.


There is no evidence of BtM becoming irrelevant for identifying value stocks. Compared to popular alternatives, BtM is at least as good at producing dispersion in average returns. This ability has not declined in recent years. The changes in the composition of the US economy during the past several years have not eliminated the strong cross-sectional relation between BtM and realized returns.

There is one advantage of BtM relative to its peers that should be mentioned. Since book value is a "stock" variable, while earnings, cash flow and sales are "flow" variables, there is a tendency for BtM rankings to be somewhat more stable over time than the rankings based on the other three variables. This reduces portfolio turnover for strategies that are based on BtM rankings. So, in addition to providing at least as much return dispersion as its competitors, BtM may also reduce the number of transactions that are triggered by stocks moving in and out of the portfolio's buy range. This can be especially important for taxable investors.

The helpful comments of David G. Booth, Andrew Cain, Truman A. Clark, Eugene F. Fama, Kenneth R. French, Mark R. Gochnour, Eduardo A. Repetto, Rex A. Sinquefield, and Weston J. Wellington are gratefully acknowledged.

1 The sample each year is restricted to firms that have positive values for sales, book value, earnings, and cash flow. This is done so that each firm can be included in all four rankings. Market values are taken from CRSP, and accounting variables are taken from Compustat.

2 It can be argued that ranking variables should be judged by average absolute return differences rather than average return differences. Using absolute return differences does not change any of the conclusions of this study. Since 1963, BtM has produced the largest absolute return difference in twelve of the thirty-seven years. Sales/price, earnings/price and cash flow/price produced the largest absolute dispersion in eleven, eight, and six years, respectively.

This article contains the opinions of the author and those interviewed by the author but not necessarily Dimensional Fund Advisors Inc. or DFA Securities Inc., and does not represent a recommendation of any particular security, strategy or investment product. The author's opinions are subject to change without notice. Information contained herein has been obtained from sources believed to be reliable, but is not guaranteed. This article is distributed for educational purposes and should not be considered investment advice or an offer of any security for sale. Past performance is not indicative of future results and no representation is made that the stated results will be replicated.


January 2001