Price/Book, Operating Leverage and Market Returns
It is generally accepted in corporate finance that higher levels of operating risk (operating leverage) and higher use of leverage (financial risk) will increase equity risk and thus investors will require a higher return from the stock.
In the May 2007 Journal of Accounting Research, Penman, Richardson and Tuna examine the positive relationship between the book/price ratio and subsequent stock market returns by separating book/price into operating leverage and financial leverage effects.
The authors define “enterprise book-to-price” as the net operating assets divided by market price and use it as a proxy for operating risk. Leverage is net debt divided by the market value of equity. They find that operating leverage does has a positive relationship to subsequent stock returns, but that financial leverage has a negative relationship.
For more information, see all articles on: Investing in Stocks, Portfolio Management, Ratio Analysis, Research See also:
The Intelligent Investor: The Classic Text on Value Investing
Financial Statement Analysis: A Practitioner's Guide, 3rd Edition
Managing Investment Portfolios: A Dynamic Process (CFA Institute Investment Series)
