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price-to-book ratio not behaving as supposed
Axel Borasino Marqués
posted
Finance Theory Seeking Help Using Data Pipeline

Hi Community,

I was diggin into a fundamental ratios based strategy that i have developed myself, when i found out that one of my ranking ratios (Fundamentals.pb_ratio.latest) was not producing the expected mean return on the top/bottom percentiles.

As long as I am concerned, this valuation ratio should have a positive mean return for the bottom percentile and a negative one for the top percentile (LOW-VALUE-RANKS-BETTER ratio) according to modern portfolio theory and factor investing. As you can see, I have restricted the possible values of this ratio to skip outliers that would biase the z-score, but i can't find the reason why the ranking system is not behaving as it should ( as can be shown on the first graph of alphalens "Mean return by factor quantile").

Any help/ideas will be more than welcomed!!

Thank you all!

2 responses
Juan Imbet

Hello! There has been some evidence that value investment by itself is not that profitable after the financial crisis. If you try the same strategy with other measures of value, e.g. value score, E/P, B/M you will find similar results.

Dan Whitnable

The 'book' value of a company is the sum of all the assets minus its liabilities. It's one way to measure the value of a company but it doesn't take into account other measures where a company generates value. The single greatest asset most companies have is their 'human capital'. Additionally, many companies generate value from their brands or market position. These aren't captured in the Price/Book valuation.

This can actually be seen pretty well in the above notebook. Look specifically at the cell with alphalens.plotting.plot_quantile_returns_bar(mean_return_quantile_sector, by_group=True). The resulting graphs show that 'Basic Materials' and 'Real Estate' do follow the expectations that low P/B would have higher returns than high P/B. That makes sense for those sectors where value is produced directly from material assets. The other sectors such as 'Technology' however, create value via human capital and ideas and show very little correlation with P/B.

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The material on this website is provided for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation or endorsement for any security or strategy, nor does it constitute an offer to provide investment advisory services by Quantopian.

In addition, the material offers no opinion with respect to the suitability of any security or specific investment. No information contained herein should be regarded as a suggestion to engage in or refrain from any investment-related course of action as none of Quantopian nor any of its affiliates is undertaking to provide investment advice, act as an adviser to any plan or entity subject to the Employee Retirement Income Security Act of 1974, as amended, individual retirement account or individual retirement annuity, or give advice in a fiduciary capacity with respect to the materials presented herein. If you are an individual retirement or other investor, contact your financial advisor or other fiduciary unrelated to Quantopian about whether any given investment idea, strategy, product or service described herein may be appropriate for your circumstances. All investments involve risk, including loss of principal. Quantopian makes no guarantees as to the accuracy or completeness of the views expressed in the website. The views are subject to change, and may have become unreliable for various reasons, including changes in market conditions or economic circumstances.