Decomposing the Book-to-market

Abstract

We explore the relation between book-to-market and stock returns by decomposing the ratio into balance sheet subcomponents: retained earnings, contributed capital and accumulated other comprehensive income. Taking account of the explicitly different natures of these subcomponents, we propose that they potentially contain independent information about stock returns. In 2001 to 2016 Korean stock market, we find that book-to-market as a whole predicts the cross-section of stock returns better than its subcomponents. Retained earnings-to-market has a positive relation with stock returns. Contributed capital-to-market and accumulated other comprehensive income-to-market do not seem to provide unique and valuable information about stock returns. Of the three subcomponents, only retained earnings-to-market subsumes (partially) book-to-market's return predictability. Lastly, both book-to-market and retained earnings-to-market fail to significantly absorb the return predictability of earnings-to-price.