A stock with a low price-to-book (PB) ratio is cheap, based on the price of acquiring its book equity. This factor does not take the earnings power of the company into consideration and relies on the assets and liabilities of the company being fairly valued. The price-to-book value was a favourite tool of Benjamin Graham and other earlier value investors. Despite its shortcomings, PB is a strong factor in generating market outperformance and works well with other factors, as you will see later.
Investors who believe PB is an important factor when looking for bargains would be correct. It certainly is for the mid-cap companies, with Q1 generating market outperformance of 12,1% pa and Q5 underperforming the market by 8,5 % pa. For the other company sizes, the factor is less strong. However, for all three company sizes, it led to market outperformance between 66% and 75% of the time over the 12-year test period.
Of all the factors we tested, a low PB strategy applied to mid-cap companies led to the highest return of 400,3% over 12 years. That was nearly 370% better than the market portfolio. It did not work well for large-cap companies, returning only 203,6%, and was even less successful when applied to small companies, leading to a 172,5% return. So over the 12 years tested, you would have been well rewarded if you used only a low price-to-book strategy.