Going by the Book: Valuation Ratios and Stock Returns

Abstract

We study the use of book-to-market ratios (B/M) in value investing and its implications for comovements in firms' stock returns and trading volumes. We show B/M has increasingly detached from alternative valuation ratios while becoming worse at forecasting returns and growth in an absolute and relative sense. Despite these trends, major U.S. stock indexes and institutional funds continue relying on B/M when identifying value stocks. Consistent with this reliance shaping market outcomes, we find firms' stock returns and trading volumes comove with B/M-peers (i.e., firms with similar B/M) in excess of their fundamentals, particularly among stocks held by value-oriented funds.