The Enterprise Multiple Factor and the Value Premium

Abstract:     
Following the work of Fama and French (1992, 1993), there has been wide-spread usage of book-to-market as a factor to explain stock return patterns. In this paper, we highlight serious flaws with the use of book-to-market and offer a replacement factor for it. The Enterprise Multiple, calculated as (equity value debt value preferred stock - cash)/EBITDA, is better than book-to-market in cross-sectional monthly regressions over 1963-2008. In the top three size quintiles (accounting for about 94% of total market value), EM is a highly significant measure of relative value, whereas book-to-market is insignificant. The significance of EM is also confirmed with UK and Japanese data. We use the Enterprise Multiple to create an EMD factor which generates a return premium of 5.76% per year.

Keywords: Enterprise Multiple, Fama French factors, book-to-market

JEL Classifications: G12, G14

Working Paper Series