The Profitability of Trading Strategies Based on Book Value and Earnings in Hong Kong: Market Inefficiency vs. Risk Premia

Using a sample of Hong Kong firms, we have examined the relative and incremental usefulness of book‐to‐price ratio (B/P), and earnings‐to‐price ratio (E/P) for providing profitable trading strategies or for predicting stock returns. Our results show that trading strategies based on B/P or E/P yield significant excess returns for various holding periods up to two years, and that B/P and E/P are not only individually but also incrementally useful for predicting stock returns. Further, results of various tests indicate that trading profits observed from the B/P strategy are likely to be a result of B/P proxying for risk differentials, while those from the E/P strategy are related to gains from exploitation of market inefficiency or mispricing. The two ratios appear to capture different aspects of firm value in Hong Kong.