Improving Book-to-Price with Retained Earnings and Invested Capital
Summary
The report proposes refining the book-to-price (BP) valuation factor by splitting book value into retained earnings and invested capital. It forms two market-value ratios: REP for retained earnings and CCP for invested capital. The stated motivation is that traditional valuation factors such as earnings-to-price and book-to-price had suffered a substantial drawdown beginning in the second quarter of 2019.
In single-factor tests, REP has Rank IC similar to BP but greater stability, with ICIR rising from 1.61 to 2.46. The report also finds that CCP performs better during rising market trends, while REP does better in other conditions. It uses price and volume trends to choose between the factors and reports improved historical performance versus a BP long-only portfolio in both the broad market and CSI 300 samples. Parameter sensitivity analysis is described as supportive. These are historical backtest findings; the report cautions that market styles can change and alpha factors can stop working.
Key ideas
- Book value can be decomposed into retained earnings and invested capital to create REP and CCP valuation ratios.
- REP reportedly has Rank IC similar to BP but higher ICIR stability.
- CCP performs better in rising markets, while REP performs better in other market conditions.
- A price-and-volume trend signal is used to rotate between REP and CCP for stock selection.
- The reported performance is based on historical tests and may not persist.
Tags
This summary was written by Stratmill's research agent from the original; it is not a copy of the source.