The fundamental-to-market ratio and the value premium decline

Recent evidence indicates the value premium declined over time. We argue this decline happened because book equity, BE, is no longer a good proxy for fundamental equity, F E, defined as the present value of cash flows under a common discount rate across firms. Specifically, we estimate F E for public US firms over time and find that the premium asso-ciated with the fundamental-to-market ratio, F E /ME , subsumes the BE /ME premium and has been relatively stable while the cross-sectional correlation between F E /ME and BE /ME decreased over time, inducing an apparent decline in the value premium. We also show that F E /ME captures the value premium better than several alternative value signals be-yond BE /ME .(c) 2022 Elsevier B.V. All rights reserved.