Market-to-book production efficiency and future stock performance

초록

Market-to-book ratios, such as the market-to-book equity ratio, are known to explain average stock returns. Such ratios, however, do not incorporate cross-firm differences in the input-output structure employed to generate a firm’s market and book outputs. In this paper, we propose a version of the market-to-book ratio based on the production efficiency which considers cross-firm differences in the input-output structure, and investigate its relationship with future stock returns. Specifically, we use the industry-wise rank difference between a firm’s sales-oriented and market value-oriented efficiency scores based on the data envelopment analysis technique. Using US data from 1980 to 2015, we find that firms with high (low) sales-oriented and low (high) market value-oriented efficiency scores have the best (worst) future stock returns. A long/short equity investment strategy based on the rank difference generates significantly positive returns and outperforms long/short strategies based on either the sales-oriented or market value-oriented efficiency score or the market-to-book equity ratio. The profitability of the strategy remains significant across most industries and robust to controlling for common risk and momentum factors, to sub-period analyses, and to several alternative ways of measuring the efficiency scores. Taken together, the findings suggest that such a market-to-book ratio based on the production efficiency provides valuable insights into the risks and opportunities faced by a firm.

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