Accounting Valuation, Market Expectation, and the Book-to-Market Effect

Abstract

Accounting-based valuation theory suggests that a firm's value (V) is a combination of its book value (B) and market expectations of future earnings. We empirically evaluate the ability of this model to explain the book-to-market (B/P) effect. We find that our empirical proxies of V dominate B in cross-sectional correlations with price, and that the resulting V/P ratios also predict cross-sectional returns. In addition, we find that errors in analyst consensus forecasts are predictable, and that returns from trading on these predictable errors account for much of the B/P effect.

JEL Classification: G12, G14, M41