Valuation Beta: Addressing Inadequacies of Book to Price with Intrinsic Value, Stewardship and Leverage

Abstract

A five-factor asset pricing model that incorporates direct measures of excess intrinsic value, financing yield, and leverage outperforms commonly studied models built solely upon book to price and dividend discount model frameworks. Excess intrinsic value captures firm value derived from discounted future economic profits net of the book equity reported on a firm’s balance sheet. Financing yield consolidates independent profitability and growth factors motivated from a dividend discount model framework into a single factor, untethering the incorrect assumption that predicts capital growth unconditionally leads to negative stock returns. A direct measure of leverage subsumes book to price over our study horizon. Studying the common ex-post horizon of the book to price factor and Applied Finance Intrinsic Value Factor provides compelling out-of-sample performance to support the theoretical motivation of a valuation-based approach to explain cross-sectional returns.