If you’re familiar with factor investing, you’re likely aware that value investing, particularly in the U.S. market, has had a challenging stretch over the last 10 years. If you dig deeper into the darker recesses of factor investing nerdery, you’ll also find that the validity of book value — one of the traditional measures of quantitative value — as a measure of a company’s intrinsic value is under assault. The basic claim is that intangible assets (research and development expenses, brand name, intellectual capital, etc.) have become such a large fraction of intrinsic value for many companies that book value, which doesn’t generally account for intangible assets, is being rendered useless.

Another claim is that book value is being distorted by the prevalence of share buybacks, which can potentially increase the stock price/book value measure beyond what it otherwise would be or even push book value into negative territory. Following the logic, continuing to use price/book value to sort companies into value and growth categories is then categorizing some companies that are truly value companies into growth companies and vice versa, as well as potentially discarding companies altogether if book value is negative. Presumably, again continuing with the logic, investors and their fund managers should either discard book value or replace it with other measures like earnings, cash flow and sales. Admittedly, many of the articles about book value are logically convincing, and many of the points made, as we will see below, are no doubt indisputable. Furthermore, I personally think it’s fine to use other measures of value (e.g., price/earnings, price/sales, price/cash flow, etc.) in lieu of or as supplements to book value. So what’s my beef?

My beef is that many of these articles are lean on any tangible, returns-based evidence that other measures of value are now clearly superior — or becoming superior — to price/book. In other words, all accounting measures are by definition flawed (e.g., the price/cash flow measure can be negative, earnings can be manipulated, cash-flow-based measures can generate higher portfolio turnover, etc.), and it would be a weird result if one measure were either clearly superior or inferior to all others, particularly when stock price is included in each measure. So let’s examine the evidence, starting with the trend toward more negative book value companies.

The Trend Toward Negative Book Value

Using Professor Ken French’s data library, Figure 1 plots the historical percentage of companies with negative book value, while Figure 2 plots the historical percentage of market capitalization represented by negative book value companies.

Figure 1: Percentage of U.S. Companies with Negative Book Value

Figure 2: Percentage of U.S. Market Capitalization with Negative Book Value

We see that whether we measure the percentage by companies or by market capitalization, it’s increasing. Starting around 2013, both measures started moving upward and through early 2019 are at levels higher than at any other point in history. Roughly 6 percent of companies have negative book values, and about 3 percent of market capitalization is represented by negative book value companies. Whether the trajectory will continue or reverse is not known, but it is true that negative book value is meaningf