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Highlights & Takeaways
- The BVPS-to-Price ratio, also known as the Book Value per Share to Price ratio, is a financial metric used to evaluate the valuation of a company’s stock. It compares the book value per share (BVPS) of a company to its current stock price.
- The book value of a stock represents the net value of a company’s assets, liabilities, and shareholders’ equity. It provides an estimation of the company’s value if all its assets were sold and all its debts were settled.
- Empirical findings from SP 500, Russell 1000, and Russell 2000 challenge the notion that stocks deemed “undervalued” based on the BVPS-to-Price ratio are attractive investment opportunities. Instead, these stocks often turn out to be “value traps”, indicating that the companies themselves are facing difficulties and making investors suffer loss.
- To conclude, it is recommended to AVOID holding stocks with very high BVPS-to-Price ratios, as the metric is not a decent value investing indicator.
Introduction & Intuition
BVPS-to-Price = Book Value per Share / Stock Current Price
Based on its definition, BVPS-to-Price ratio is a potential indicator for value investing. A high BVPS-to-Price ratio suggests that the stock may be undervalued, indicating that the book value per share is relatively higher than the market price, and the vice versa.
In this section, we will examine whether above argument holds true from a quantitative perspective.
Factor Study Framework
We will analyze the performance of stocks with higher BVPS-to-Price compared to those with lower BVPS-to-Price during the period of January 2000 to March 2023, using the following framework to determine which group delivers better returns.
BVPS-to-Price Ratio Factor in SP 500
The following results (Jan 2000 — Mar 2023) are displayed.
- Quintile Annualized Returns (both total return and alpha return).
- Quintile Long-Short Cumulative Returns, where the best quintile (Q1) is long and the worst quintile (Q5) is short.
1. Quintile Annualized Returns
Just as a reminder, we use two types of return measures in our analysis. Total return measures the overall return from the stock, which includes both the market return and the stock selection return. On the other hand, alpha return focuses solely on the stock selection return by removing the market return component from the stock return. This distinction will allow us to evaluate the effectiveness of the BVPS-to-Price factor more precisely.
Details on two return components can be found:
Quintile Analytics
Observations:
- Companies with the highest BVPS-to-Price ratios tend to deliver significantly lower annualized returns compared to the SP500 universe. Additionally, these stocks exhibit poor risk metrics, including high return volatility, low Sharpe ratio, and substantial max drawdown.
- When a company’s stock is trading at a significant discount (close to or even below) its book value, it is important to recognize that it is not merely an “undervalued” opportunity. Instead, it may indicate that the company is facing financial difficulties and requires additional scrutiny before considering an investment.
2. Quintile Long-Short Cumulative Returns
Long-Short (Q1 — Q5) Return Analytics (Monthly)
Observations:
- Over the past two decades, there hasn’t been a substantial disparity in returns between stocks with the lowest BVPS-to-Price ratios (considered “undervalued” names) and those with the highest BVPS-to-Price ratios (termed “overvalued” names). However, it is important to note that since 2007, stocks with low BVPS-to-Price ratios consistently underperformed those with high BVPS-to-Price ratios. This observation highlights the significance of conducting thorough investigations when stocks are trading at very low BVPS-to-Price ratios, as it is not a straightforward “cheap and buy” signal.
BVPS-to-Price Ratio Factor in Russell 1000 and Russell 2000
It is worth noting that the S&P 500 index consists of the 500 largest and most actively traded companies in the US, where stocks are generally priced more efficiently than in other stock universes.
To determine whether our conclusions hold true in different stock universes, we extended our study to include the Russell 1000 and Russell 2000 universes. This expansion allowed us to compare the performance of stocks with higher BVPS-to-Price ratios to those with lower BVPS-to-Price ratios under different market conditions and environments.
- Quintile Annualized Returns
2. Quintile Long-Short Cumulative Returns
Observations:
- During the observed time period, the cumulative long-short total return and alpha return in both the Russell 1000 and Russell 2000 universes have been positive. However, it is noteworthy that the behavior of BVPS-to-Price ratios in these universes follows a similar pattern to that observed in the SP 500. This suggests that the relationship between BVPS-to-Price ratios and performance is consistent across these different market segments.
- In general, it is reasonable to conclude that the BVPS-to-Price ratio should be utilized more as an indicator to identify potential “value traps” rather than as a sole value-driven factor in the US stock market.
Notes:
- All data in the analysis are sourced from Yahoo Finance & Financial Modeling Prep.
- Past performance is no guarantee for future investment results.
- Thanks for reading! Feel free to leave questions in the comment section.