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Relationship between ‘risk’ and stock returns

Relationship between ‘risk’ and stock returns. Mayur Agrawal Varun Agrawal Debabrata Mohapatra Sung Kyun Park Vikas Yadav. Risk 4: Price to Book Ratio. P/B = Market Cap / Book Value of Equity Market Cap = S hares Outstanding * Market price per Share

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Relationship between ‘risk’ and stock returns

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  1. Relationship between ‘risk’ and stock returns Mayur Agrawal Varun Agrawal Debabrata Mohapatra Sung Kyun Park VikasYadav

  2. Risk 4: Price to Book Ratio • P/B = Market Cap / Book Value of Equity • Market Cap = Shares Outstanding * Market price per Share • BV of Equity = BV of Assets – BV of Intangible Assets – BV of Liabilities

  3. Compares market’s valuation of company to the value of company indicated by its balance sheets • Low P/B ratio => Company undervalued => More Return • Value Investors v/s Growth Investors

  4. P/B Calculation • CRSP data for Market Cap • Permno as primary key which tracks security • COMPUSTAT data for Book Value of Equity • GVKey as primary key which tracks company • Mapping between Permno and GVKey is not one to one

  5. PermnoGVKey • Used CCM (CRPS COMPUSTAT Merged) to get the mapping between permno and gvkey • Steps: • Get gvkeys of all SnP500 constituents from 1962 to 2008 • Get data for all gvkeys from CCM with fields • gvkey • lpermno(same as CRSP permno) • effective start date • effective end date

  6. PermnoGVKey (conti…) • The previous step gives GVKey Permno mapping • Process it to get Permno GVKey • Permno mapped to (Eff Begin Date, Eff End Date, GVKey) tuples EX:

  7. Issues with the Mapping • Using CCM could only get 1450 permno as compared to 1526 in CRSP • The permnos that are present in the mapping can also have some data missing • Proposed Solution • Manually finding the mapping of the missing 76 securities (last resort) • Use Ticker information to write a program to complete the mapping (investigating)

  8. Results Dec 1999 Dec 2001 Dec 2002

  9. Growth stocks have high P/B ratio because • Market’s evaluation is more that companies value • Technology Sector has high P/B ratio because • Intangible assets like intellectual property rights etc. are of much more value • Intangible asset is a negative term in the denominator • Dot com Bubble (till mid 2000) and Burst (2001 and 2002)

  10. Dec 2006 Dec 2004 Dec 2003 Dec 2005

  11. Dec 2008 • Companies with low p/b ratio tend to perform better

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