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Looking at the Evidence

Some investors argue that stocks that trade at low price-book-value ratios are undervalued, and several studies seem to back a strategy of buying such stocks. You will begin by looking at the relationship between returns and price-to-book ratios across long periods in the United States and extend the analysis to consider other markets.

Evidence from the United States

The simplest way to test whether low price-to-book stocks are good investments is to look at the returns that these stocks earn relative to other stocks in the market. An examination of stock returns in the United States between 1973 and 1984 found that the strategy of picking stocks with high book/price ratios (low price-book values) would have yielded an excess return of 4.5% a year.[1] In another analysis of stock returns between 1963 and 1990, firms were classified on the basis of price-to-book ratios into 12 portfolios. Firms in the highest price-to-book value class earned an average monthly return of 0.30%, while firms in the lowest price to book value class earned an average monthly return of 1.83% for the 1963–1990 period.[2]


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