The Fundamental-to-Market Ratio and the Value Premium Decline

65 Pages Posted: 13 Apr 2020 Last revised: 10 May 2021

See all articles by Andrei Gonçalves

Andrei Gonçalves

University of North Carolina (UNC) at Chapel Hill - Finance Area

Gregory Leonard

University of North Carolina at Chapel Hill

Date Written: May 7, 2021

Abstract

Recent evidence indicates the value premium declined over time. In this paper, we argue this decline happened because book equity, BE, is no longer a good proxy for fundamental equity, FE, defined as the equity value originating purely from cash flows. Specifically, we estimate FE for public US firms (from 1973 to 2018) and find that the premium associated with the fundamental-to-market ratio, FE/ME, subsumes the BE/ME premium and has been stable while the cross-sectional correlation between FE/ME and BE/ME decreased over time, inducing an apparent decline in the value premium. We also show that FE/ME provides a better value premium signal than several alternative valuation ratios beyond BE/ME.

Keywords: Value Premium, Book-to-Market, Valuation Ratios, The Cross Section of Expected Returns

JEL Classification: C58, E44, G10, G11, G12

Suggested Citation

Gonçalves, Andrei and Laonard, Gregory, The Fundamental-to-Market Ratio and the Value Premium Decline (May 7, 2021). Kenan Institute of Private Enterprise Research Paper , Available at SSRN: https://ssrn.com/abstract=3573444 or http://dx.doi.org/10.2139/ssrn.3573444

Andrei Gonçalves (Contact Author)

University of North Carolina (UNC) at Chapel Hill - Finance Area ( email )

Kenan-Flagler Business School
Chapel Hill, NC 27599-3490
United States

Gregory Laonard

University of North Carolina at Chapel Hill ( email )

Chapel Hill, NC
United States

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