The comparison of return on equity with price to book (or the enterprise value equivalents) is a common form of analysis. Some investors claim that the often high correlation between these measures indicates the importance of return on capital. However, all is not what it seems.
This analysis is, in reality, a comparison of price earnings ratios. Adding capital employed may provide additional insight but remember that aggregate returns are most value relevant if they are a predictor of forward-looking incremental returns.Continue reading “Price to book versus ROE analysis: A case of random numbers?”