Most academic research suggests that investing in glamour stocks is a losing proposition.
On average, firms with high valuations determined by factors such as the price-earnings ratio or price-to-book-value ratio underperform the market over the long term. While the market does a good job of valuing securities in the long run, in the short term it can overreact and push prices away from their true value.
Stocks with high prices compared to their book values tend to be glamour or growth companies that have attracted significant investor attention. As investors pile into a growth stock because of hype, strong relative price strength or high past or expected growth, its price deviates further from its underlying fundamental value. As with value investing, some growth stocks deserve their high valuations, while many do not. Partha Mohanram, CGA Ontario professor of financial accounting at the University of Toronto’s Rotman School of Management, developed a scoring system to help separate the winners from the losers among stocks trading with high price-to-book-value ratios.
The price-to-book-value ratio is determined by dividing market price per share by book value per share. Book value is generally determined by subtracting total liabilities from total assets and then dividing by the number of shares outstanding. It represents the value of the owners’ equity based upon historical accounting decisions. If accounting truly captured the current value of the firm, then one would expect the current stock price to be near the firm’s accounting book value. Over the history of a firm, many events occur that can distort the book value figure. For example, inflation may leave the replacement cost of capital goods within the firm far above their stated book value. Different accounting policies among industries may also come into play when screening for high price-to-book stocks.
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