In Revival of Value Investing, Price-to-Book Back in Vogue

Updated on
  • Of four methods to pick cheap stocks, price-to-book won in ’16
  • Morgan Stanley joins Jefferies to tout strategy in year ahead

Buying stocks based on a low price-to-book value has been a terrible way to invest for a decade. Not any more.

This staple of value investing was the best of four key methods to identify cheap equities in 2016, according to calculations by Bloomberg News, and will remain a “valid and relevant metric” in the year ahead, strategists at Morgan Stanley said.

“Having been much maligned and ignored for the last decade,” price-to-book is making a comeback, the strategists, including Graham Secker, wrote in a recent note. “It should enjoy a strong revival as earnings recover and inflation/rates move higher.”

Backtest of Stoxx 600 based on average return for top-bottom quantile annualised for each measure

Interest in so-called “value” shares is growing globally as cash flows from bonds to equities, and investors bet on faster economic growth. Selecting stocks based on a low ratio of a company’s share price to its book value correlates most closely with the relative performance of value over growth stocks, according to Morgan Stanley. A net 43 percent of investors expect value shares to outperform growth stocks over the next 12 months, up from 39 percent last month, according to Bank of America Merrill Lynch’s global fund manager survey published today.

The strategy beat low price-to-earnings ratios, high dividend yields and high free-cash-flow yields as a selection method in 2016. The best performing of the four valuation methodologies over the last decade has been high free-cash-flow yields, according to data compiled by Bloomberg from Europe’s Stoxx 600 index. Price-to-book was worst.

Backtest of Stoxx 600 based on annualised monthly return spreads between top and bottom quintiles for each measure

The Morgan Stanley view echoes that of Jefferies Group LLC, which points to market conditions favoring low price-to-book value shares, according to a recent client note from strategists led by Sean Darby. Meanwhile, higher rates and better economic activity are “likely to prove a drag on expensively-valued stocks,” they said.

“The good news is there are plenty of cheap stocks,” the strategists said. “Based on turnover criteria and a market value of more than $500 million, around 23 percent of global stocks trade below 1.25 times price-to-book.”

Banking, energy and insurance sectors are a good source of low price-to-book value shares, Morgan Stanley said.

(Updates story with data from BofAML’s global fund manager survey.)
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