Value Investing with Dividend-to-Market Ratio

43 Pages Posted: 24 Jul 2016

Date Written: July 12, 2016

Abstract

The book-to-market ratio (BM) is a noisy metric for value investing because book value is a weak indicator of intrinsic value. Using the dividend discount model of Miller and Modigliani (1961), this paper proposes an alternative metric for value investing: the dividend-to-market ratio (DM), where dividend is measured as profitability minus investment. Test results show that DM effectively distinguishes between undervalued stocks and overvalued ones, leading to substantial economic gains. Further, DM is a parsimonious, more efficient measure to estimate expected returns than a linear model consisting of BM, profitability and investment. An investor can increase a portfolio's Sharpe ratio by adding a DM factor rather than a combination of the BM, profitability and investment factors.

Keywords: value investing, dividend-to-market ratio, asset pricing

JEL Classification: G11, G12

Suggested Citation

Dai, Yiqing, Value Investing with Dividend-to-Market Ratio (July 12, 2016). Available at SSRN: https://ssrn.com/abstract=2813111 or http://dx.doi.org/10.2139/ssrn.2813111

Yiqing Dai (Contact Author)

University of Adelaide ( email )

Adelaide, Australian Capital Territory
Australia

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