30 Years Pursuing the Value Premium: Price-to-Book Stands the Test of Time
-
An analysis shows no reliable performance differences across value portfolios formed on price-to-book (P/B) vs. nine other metrics.1
-
P/B separates the value and profitability premiums effectively, allowing investors to better manage exposure to those premiums.
-
A P/B strategy can achieve performance similar to that of other metrics, with less turnover.
This year marks Dimensional’s 30th anniversary of managing value strategies for our clients. For three decades, Dimensional has been successfully targeting the value premium to help investors pursue higher expected returns.
The value premium is supported by strong empirical evidence and motivated by valuation theory, which provides a framework for identifying the drivers of expected returns. Valuation theory says that expected returns are driven by the prices investors pay and the cash flows they expect to receive. We can use the valuation equation shown in Exhibit 1 to identify relations across prices and company fundamentals that tell us about differences in expected returns across securities. In particular, the valuation equation tells us that stocks with a lower relative price (“value” stocks), a smaller market capitalization, and higher profitability2 have higher expected returns than stocks with a higher relative price (“growth” stocks), larger market capitalization, and lower profitability.
Valuation Equation
When it comes to identifying value and growth stocks, Dimensional uses price-to-book (P/B), one of the original metrics proposed in academia and the financial industry. P/B is the ratio of market capitalization (price) to book equity. While there are many alternative metrics, including price-to-earnings (P/E), price-to-cash flow (P/CF), and intangible adjusted P/B, a recent Dimensional paper, “Assessing Alternative Value Metrics,” finds that P/B stands out from practical investment perspectives.
Examining hypothetical value portfolios based on 10 alternative valuation metrics, the paper shows that there is no reliable performance difference between the portfolio formed on P/B and portfolios formed on the alternative metrics. Indeed, all value portfolios outperformed the broad US market, providing evidence for the robustness of the value premium.
The paper also documents a common feature among most alternative value metrics: additional profitability exposure at the expense of lower value exposure.
Incorporating profitability in addition to the value premium can be a powerful way to improve the expected returns of a portfolio. However, to integrate the value and profitability premiums most effectively, we believe a real-world strategy should directly target exposure to both premiums, rather than relying on indirect exposure to the profitability premium through alternative value metrics. Moreover, accessing the value and profitability premiums via separate variables allows for more direct control over the desired exposure to those premiums.
In practical investment solutions, we also need to consider the impact of trading costs. The hypothetical value strategy constructed using P/B results in lower turnover than the value portfolios formed on P/E and P/CF, reducing implementation costs. This makes sense because book equity tends to be less volatile than other fundamentals on income statements, such as earnings and cash flows.
Over the past 30 years, investors have searched for new ways to extract information related to the value premium. Ongoing research from Dimensional indicates that P/B can provide a similar expected return with lower turnover and more control over the exposure to multiple premiums in a systematic investment solution. When evaluated based on empirical and practical considerations, price-to-book—one of the original value metrics—stands the test of time.
Footnotes
- 1The alternative value metrics are price-to-cash flow, price-to-earnings, price-to-retained earnings, price-to-contributed capital, price-to-book less goodwill, price-to-book with estimated intangibles, price-to-book with estimated knowledge capital, price-to-book with estimated organizational capital, and blend of price-to-book, price-to-cash flow, and price-to-earnings.
- 2Profitability is defined as the operating income before depreciation and amortization minus interest expense divided by book equity.
Disclosures
FOR PROFESSIONAL USE ONLY. NOT FOR USE WITH RETAIL INVESTORS OR THE PUBLIC.
The information in this material is intended for the recipient’s background information and use only. It is provided in good faith and without any warranty or representation as to accuracy or completeness. Information and opinions presented in this material have been obtained or derived from sources believed by Dimensional to be reliable, and Dimensional has reasonable grounds to believe that all factual information herein is true as at the date of this material. It does not constitute investment advice, a recommendation, or an offer of any services or products for sale and is not intended to provide a sufficient basis on which to make an investment decision. Before acting on any information in this document, you should consider whether it is appropriate for your particular circumstances and, if appropriate, seek professional advice. It is the responsibility of any persons wishing to make a purchase to inform themselves of and observe all applicable laws and regulations. Unauthorized reproduction or transmission of this material is strictly prohibited. Dimensional accepts no responsibility for loss arising from the use of the information contained herein.
This material is not directed at any person in any jurisdiction where the availability of this material is prohibited or would subject Dimensional or its products or services to any registration, licensing, or other such legal requirements within the jurisdiction.
“Dimensional” refers to the Dimensional separate but affiliated entities generally, rather than to one particular entity. These entities are Dimensional Fund Advisors LP, Dimensional Fund Advisors Ltd., Dimensional Ireland Limited, DFA Australia Limited, Dimensional Fund Advisors Canada ULC, Dimensional Fund Advisors Pte. Ltd., Dimensional Japan Ltd., and Dimensional Hong Kong Limited. Dimensional Hong Kong Limited is licensed by the Securities and Futures Commission to conduct Type 1 (dealing in securities) regulated activities only and does not provide asset management services.
RISKS
Investments involve risks. The investment return and principal value of an investment may fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original value. Past performance is not a guarantee of future results. There is no guarantee strategies will be successful.
UNITED STATES
This information is provided for registered investment advisors and institutional investors and is not intended for public use. Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission.
CANADA
This material is issued by Dimensional Fund Advisors Canada ULC for advisors, dealers, and institutional investors and is not intended for public use. The other Dimensional entities referenced herein are not registered resident investment fund managers or portfolio managers in Canada.
This material is not intended for Quebec residents.
Commissions, trailing commissions, management fees, and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Unless otherwise noted, any indicated total rates of return reflect the historical annual compounded total returns, including changes in share or unit value and reinvestment of all dividends or other distributions, and do not take into account sales, redemption, distribution, or optional charges or income taxes payable by any security holder that would have reduced returns. Mutual funds are not guaranteed, their values change frequently, and past performance may not be repeated.
AUSTRALIA
In Australia, this material is provided by DFA Australia Limited (AFSL 238093, ABN 46 065 937 671). It is provided for financial advisors and wholesale investors for information only and is not intended for public use. No account has been taken of the objectives, financial situation or needs of any particular person. Accordingly, to the extent this material constitutes general financial product advice, investors should, before acting on the advice, consider the appropriateness of the advice, having regard to the investor’s objectives, financial situation and needs.
NEW ZEALAND
This material has been prepared and provided in New Zealand by DFA Australia Limited, (incorporated in Australia, AFS License No.238093, ABN 46 065 937 671). This material is provided for financial advisers only and is not intended for public use. All material that DFA Australia Limited provides has been prepared for advisers, institutional investors and clients who are classified as Wholesale investors under the Financial Markets Conduct Act 2013. This material does not give any recommendation or opinion to acquire any financial advice product, and is not financial advice to you or any other person.
WHERE ISSUED BY DIMENSIONAL IRELAND LIMITED
Issued by Dimensional Ireland Limited (Dimensional Ireland), with registered office 3 Dublin Landings, North Wall Quay, Dublin 1, Ireland. Dimensional Ireland is regulated by the Central Bank of Ireland (Registration No. C185067).
Directed only at professional clients within the meaning of Markets in Financial Instruments Directive (MiFID) (2014/65/EU).
WHERE ISSUED BY DIMENSIONAL FUND ADVISORS LTD.
Issued by Dimensional Fund Advisors Ltd. (Dimensional UK), 20 Triton Street, Regent’s Place, London, NW1 3BF. Dimensional UK is authorised and regulated by the Financial Conduct Authority (FCA) - Firm Reference No. 150100.
Directed only at professional clients as defined by the rules of the FCA.
Dimensional UK and Dimensional Ireland issue information and materials in English and may also issue information and materials in certain other languages. The recipient’s continued acceptance of information and materials from Dimensional UK and Dimensional Ireland will constitute the recipient’s consent to be provided with such information and materials, where relevant, in more than one language.
NOTICE TO INVESTORS IN SWITZERLAND: This is advertising material.
JAPAN
For Institutional Investors only.
This material is deemed to be issued by Dimensional Japan Ltd., which is regulated by the Financial Services Agency of Japan and is registered as a Financial Instruments Firm conducting Investment Management Business and Investment Advisory and Agency Business.
Dimensional Japan Ltd.
Director of Kanto Local Finance Bureau (FIBO) No. 2683
Membership: Japan Investment Advisers Association
FOR LICENSED OR EXEMPT FINANCIAL ADVISORS AND INSTITUTIONAL INVESTORS IN SINGAPORE
This material is deemed to be issued by Dimensional Fund Advisors Pte. Ltd. (UEN:201210847M), which is regulated by the Monetary Authority of Singapore and holds a capital markets services license for fund management.
This material is not an advertisement, has not been reviewed by the Monetary Authority of Singapore or the Central Provident Fund (CPF) Board, and should not be shown to prospective retail investors.
For use by institutional investors and licensed or exempt financial advisors only in Singapore for internal training and educational purposes and not for the purpose of inducing, or attempting to induce, such institutional investors or financial advisors to make an investment. Not for use with the public.
FOR LICENSED FINANCIAL ADVISORS AND INSTITUTIONAL INVESTORS IN HONG KONG
This material is deemed to be issued by Dimensional Hong Kong Limited (CE No. BJE760), which is licensed by the Securities and Futures Commission to conduct Type 1 (dealing in securities) regulated activities only and does not provide asset management services.
For use by licensed financial advisors and institutional investors who are “professional investors” (as defined in the Securities and Futures Ordinance [Chapter 571 of the Laws of Hong Kong] and its subsidiary legislation) only in Hong Kong. This material is provided solely for internal training and educational purposes and is not for the purpose of inducing, or attempting to induce, such financial advisors and institutional investors to make an investment nor for the purpose of providing investment advice. Not for use with the public. This material is not intended to constitute and does not constitute marketing of the services of Dimensional Hong Kong or its affiliates to the public of Hong Kong.
Financial advisors in Hong Kong shall not actively market the services of Dimensional Hong Kong Limited or its affiliates to the Hong Kong public.