Are Two Factors Enough? The U.K. Evidence

Abstract

Some studies in the 1990s documented that book value of equity to market value of equity (BV/MV) and the market value of equity (MVE) capture the cross-sectional variation of stock returns in the U.S. market in the 1963–90 period. Other researchers argued, however, that two other variables—the sales-to-price ratio (S/P) and the debt-to-equity ratio (D/E)—have more explanatory power for stock returns than BV/MV and MVE. The evidence in this article, from London Stock Exchange data, indicates that S/P and D/E do not entirely absorb the roles of BV/MV and MVE in explaining the cross-section of average stock returns in the U.K. market. We did find that S/P has significant explanatory power beyond the contribution of BV/MV and MVE, but the explanatory power of D/E is captured by S/P.