Relations between portfolio returns and market multiples

We examined the relations of various market multiples with subsequent annual returns for portfolios of liquid U.S. stocks. In univariate regressions, price/sales (P/S) has the most consistently significant negative relation and highest explanatory power. Multivariate regression models, decomposing P/S into other market multiples and various profitability ratios, have greater explanatory power. The component of P/S that has the most consistently significant negative relationship with returns is the net profit margin. This finding is consistent with earlier evidence that the value premium reflects market overreaction to both the depressed profitability of value stocks and high profitability of growth stocks.