Has The Price-To-Book Metric Become Redundant –

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Has The Price-To-Book Metric Become Redundant –

Just finished reading a great paper by O’Shaughnessy Asset Management that discusses whether the traditional Price-to-Book metric has become redundant because of the increase in shareholder transactions, primarily through the increase in share repurchases. Here’s an excerpt from that paper:

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Value has broadly been accepted as an investing style and, historically, portfolios formed on cheap valuations have outperformed expensive portfolios. But value comes in many flavors, and the factor(s) you choose to measure cheapness can determine your long-term success. In particular, several operating metrics of value, such as earnings and EBITDA, have outperformed the more traditional price-to-book (P/B) factor. A possible reason for the limited efficacy of price-to-book is because of the increase in shareholder transactions, primarily through the increase in share repurchases.

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Valuation factors have the benefit of being simple, but can also have flaws. Price-to-sales has the benefit of measuring against revenue, which is difficult to manipulate, but it doesn’t take margins into account. Price-to earnings (P/E) measures against the estimated economic output of the company, but also contains estimated expenses that can be manipulated by managers. EBITDA-to-enterprise-value (EBITDA/EV) has the benefit of including operating cost structures, but it misses payments to bondholders and the government. Even with these flaws, the factors are effective in practice. Figure 1 shows the quintile spreads of two factors within a universe of U.S. Large Stocks from 1964 through 2015.

Price-to-book is perhaps the most widely used valuation factor in the investing industry. Russell, the top provider of style indexes for the U.S. market, uses the factor as its primary metric to separate stocks into Value and Growth categories. They use price-to-book in combination with forecasted two year growth and historical five-year sales-per-share growth, but price-to-book is the chief determinant, comprising 50 percent of the methodology. Russell’s choice of price-to-book most likely comes from its long history in academic research. The seminal work on price-to-book is Fama-French’s 1992 paper “The Cross-Section of Expected Stock Returns”, which established the three-factor model of Market, Size, and Price to-Book. But when you start looking closely at price-to-book, a few issues start to become apparent.

First, the overall spread on the factor isn’t as strong as it is with other operating metrics. The spread between price-to book’s highest and lowest quintiles (see Figure 2) is only 2.8 percent—versus price-to-earnings’ 5.1 percent spread and EBITDA-to-enterprise value’s 6.0 percent spread.

Price-To-Book Metric O'Shaughnessy Asset Management

You can read the complete paper here.

Article by Johnny Hopkins, The Acquirer's Multiple

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The Acquirer’s Multiple® is the valuation ratio used to find attractive takeover candidates. It examines several financial statement items that other multiples like the price-to-earnings ratio do not, including debt, preferred stock, and minority interests; and interest, tax, depreciation, amortization. The Acquirer’s Multiple® is calculated as follows: Enterprise Value / Operating Earnings* It is based on the investment strategy described in the book Deep Value: Why Activist Investors and Other Contrarians Battle for Control of Losing Corporations, written by Tobias Carlisle, founder of acquirersmultiple.com. The Acquirer’s Multiple® differs from The Magic Formula® Earnings Yield because The Acquirer’s Multiple® uses operating earnings in place of EBIT. Operating earnings is constructed from the top of the income statement down, where EBIT is constructed from the bottom up. Calculating operating earnings from the top down standardizes the metric, making a comparison across companies, industries and sectors possible, and, by excluding special items–earnings that a company does not expect to recur in future years–ensures that these earnings are related only to operations. Similarly, The Acquirer’s Multiple® differs from the ordinary enterprise multiple because it uses operating earnings in place of EBITDA, which is also constructed from the bottom up. Tobias Carlisle is also the Chief Investment Officer of Carbon Beach Asset Management LLC. He's best known as the author of the well regarded Deep Value website Greenbackd, the book Deep Value: Why Activists Investors and Other Contrarians Battle for Control of Losing Corporations (2014, Wiley Finance), and Quantitative Value: A Practitioner’s Guide to Automating Intelligent Investment and Eliminating Behavioral Errors (2012, Wiley Finance). He has extensive experience in investment management, business valuation, public company corporate governance, and corporate law. Articles written for Seeking Alpha are provided by the team of analysts at acquirersmultiple.com, home of The Acquirer's Multiple Deep Value Stock Screener. All metrics use trailing twelve month or most recent quarter data. * The screener uses the CRSP/Compustat merged database “OIADP” line item defined as “Operating Income After Depreciation.”

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