The Age of Book Value: Time-Weighted Book-to-Market Ratio and the Cross-Section of Returns

The book-to-market ratio (BM) is a key metric used in understanding the cross-section of stock returns. The book value in BM primarily comprises contributed capital and historical earnings accumulated over the firm's lifetime. The book value of a firm is a historical number that neglects the timing of earnings and capital contributions. This paper introduces a time-adjusted book-to-market ratio (TABM) that considers the time value of money by bringing past components of book value to their present value. I compare the performance of the TABM as a forecaster of future stock returns, incremental to the conventional BM. I find that TABM outperforms BM in predictive power for short-term and long-term stock returns. My findings indicate that, despite having the same BM, firms that have recently generated value perform differently from firms with legacy book values. My results shed light on the limitations of measures using historical book values computed following US GAAP and show that the addition of time adjustments to BM significantly enhances its applicability in asset pricing models.