5. Loo king at stock returns over the decades, it is clear that stocks with low

Question

5. Loo king at stock returns over the decades, it is clear that stocks with low price to book ratios have delivered higher returns than stocks with high price to book ratios. Which of the following may best explain the extra returns? a.Row price to book stocks have higher growth potential than high price to book stocks. b. Low price to book stocks generally have higher returns on equity than high price to book stocks. c. Low price to book stocks may be riskier than high price to book stocks. d. Low price to book stocks are more likely to have intangible assets on their balance sheets.

Explanation / Answer

Low Price to Book Value ratio stocks deliver higher returns because these stocks are considered to be undervalued in the market owing to lower returns generated on asssets by its management in the past. But there is always a prospect of stronger returns with the change in management. All this is said is true with the condition that these stocks bear higher risk relative to the other strong companies in the market. Chances of higher reward against the higher risk is thus the best explanatory part.

Hence, option-(c) is the right answer.

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