This paper lays out a decomposition of book-to-price (B/P) that derives from the accounting for book value and that articulates precisely how B/P "absorbs" leverage. The B/P ratio can be decomposed into an enterprise book-to-price (that pertains to operations and potentially reflects operating risk) and a leverage component (that reflects financing risk). The empirical analysis shows that the enterprise book-to-price ratio is positively related to subsequent stock returns but, conditional upon the enterprise book-to-price, the leverage component of B/P is negatively associated with future stock returns. Further, both enterprise book-to-price and leverage explain returns over those associated with Fama and French nominated factors—including the book-to-price factor—albeit negatively so for leverage. The seemingly perverse finding with respect to the leverage component of B/P survives under controls for size, estimated beta, return volatility, momentum, and default risk.
Penman, Stephen, Scott Richardson, and Irem Tuna. "The Book-to-Price Effect in Stock Returns: Accounting for Leverage." Journal of Accounting Research 45, no. 2 (May 2007): 427-467.
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