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Modifications on Book-Valued Ratios

Author

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  • Catherine Georgiou

    (Department of Economics, Business Division, Aristotle University of Thessaloniki, 54124, Thessaloniki, Greece)

Abstract

Purpose: In this paper we try to explain US stock market variations and cash flow fundamentals by employing three different book-valued based ratios. First, we explore the explanatory capacity of the simple book-market ratio on time-varying expected returns, and procced on altering its construction so as to enhance its performance. We then run the extra mile by constructing two new ratios, the book-dividends and book-earnings ratios based on the long-run equilibrium relationships between book, dividends and earnings. Our analysis includes evidence of predictability on dividend and earnings growth rates on the S&P 500 for the most recent sample period 1926-2018. We also investigate the ratios’ forecastability by sub-sampling. Design/methodology/approach: We commence our analysis with the conventional book-market (bm) ratio and by failing to reject the hypothesis of a unit root, we propose the modified book-market (mbm) ratio, whose construction is based on the long-run equilibrium relationship between book (b) and market (m) values. We proceed on associating book values to dividends and earnings series and fix the book-earnings (be) and the dividend-book (db) ratios. We similarly modify be and db, and examine their forecasting performance on returns, dividend and earnings growth. Findings: In-sample evidence suggests that an investor who employs mbm can improve its forecasts by 37% and 41% in the 7- and 10-year return horizon, while the modified dividend-book (mdb) proves even more beneficial by explaining 53% and 59% in similar return horizons. Our modified book-earnings (mbe) has a very good in-sample fit to the earnings growth data unlike the rest of the predictors. With respect to the out-of-sample performance, mbm manages to surpass the simplistic forecast benchmark only at the 10-year horizon by 15% while mdb attains an impressive of 47% and 71% at the 7- and 10-year return horizon. Research limitations/implications: Further research is required so as to solve the earnings puzzle in terms of forecasting along with the necessity to understand the economical sources behind non-stationarity in valuation ratios. Originality/value: We believe that our paper may prove enlightening to investors focused on portfolio allocation and asset pricing and scholars interested in return forecasting, capital budgeting and risk identification.

Suggested Citation

  • Catherine Georgiou, 2022. "Modifications on Book-Valued Ratios," International Journal of Business and Economic Sciences Applied Research (IJBESAR), International Hellenic University (IHU), Kavala Campus, Greece (formerly Eastern Macedonia and Thrace Institute of Technology - EMaTTech), vol. 15(3), pages 24-37, December.
    • Handle: RePEc:tei:journl:v:15:y:2022:i:3:p:24-37
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    More about this item

    Keywords

    book-market ratio; modified book-market ratio; book-valued ratios; non-stationary ratios; modified ratios; return predictability;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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