The results of our analysis are generally a bit stronger when
the aggregate valuation measure is used, but three of eight factors (value blend, momentum, and investment) and two of eight smart beta strategies (Fundamental Index and dividend index) show a stronger correlation when the P / B valuation measure is used.11
The aggregate valuation measure is likely stronger because it captures differences in profitability that can be missed by P / B.
We observe that P / B - based valuation does a better job of forecasting the return of the value blend factor, whereas
the aggregate valuation measure does a better job of forecasting the return of the value strategy constructed based on B / P.
Our findings are robust for both factors and smart beta strategies across horizons out to five years, using both a simple price - to - book ratio and
an aggregate valuation measure, in U.S., developed ex U.S., and emerging markets.
Not exact matches
The current
valuation of the S&P 500 is lofty by almost any
measure, both for the
aggregate market as well as the median stock: (1) The P / E ratio; (2) the current P / E expansion cycle; (3) EV / Sales; (4) EV / EBITDA; (5) Free Cash Flow yield; (6) Price / Book as well as the ROE and P / B relationship; and compared with the levels of (6) inflation; (7) nominal 10 - year Treasury yields; and (8) real interest rates.
In contrast, the
aggregate measure indicates that profitability is trading very near its historical norms of relative
valuation, perhaps explained by low P / B value stocks having far less profitability than they have historically.
Almost all of the factors and smart beta strategies exhibit a negative relationship between starting
valuation and subsequent performance whether we use the
aggregate measure or P / B to define relative
valuation.9 Out of 192 tests shown here, not a single test has the «wrong» sign: in every case, the cheaper the factor or strategy gets, relative to its historical average, the more likely it is to deliver positive performance.10 For most factors and strategies (two - thirds of the 192 tests) the relationship holds with statistical significance for horizons ranging from one month to five years and using both
valuation measures (44 % of these results are significant at the 1 % level).
Generally, we observe stronger correlations with future returns when we use
aggregate relative
valuation measures compared to using P / B alone.
We use an
aggregate of four
valuation measures in addition to the sole metric of P / B, and we investigate horizons of one month and one to five years.
Value (using both forms, B / P and blended) falls in the bottom quintile of its historical
valuation in both international and emerging markets; of 12 comparisons (U.S., international, and emerging markets, constructed using both B / P and the blended
valuation, and with relative
valuation measured versus both P / B and the
aggregate measure), 11 suggest value is trading cheap, with 5 in the bottom decile of the historical
valuation range.
When relative
valuation is gauged using the
aggregate measure (reported in the right-most column of Tables 1 and 2 for both
aggregate and P / B
valuations), we find that the cheapest stocks based on B / P are no longer cheap.