An investor constructs a portfolio by going long on stocks with high book-to-market ratios and short on stocks with low book-to-market ratios. What style of investing is this?

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BlackTom AI · Accepted Answer

Question restatement: An investor constructs a portfolio by going long on stocks with high book-to-market ratios and short on stocks with low book-to-market ratios. What style of investing is this?

Option analysis (note: no answer options are provided beyond the stated correct label in the prompt):

- Understanding the described strategy: Going long on high book-to-market (B/M) stocks and short on low B/M stocks is a classic value investing tilt. High B/M stocks are typically considered value stocks because a high book value relative to price suggests the stock may be undervalued by the market, trading below what fundamentals imply. Conversely, low B/M stocks are often growth or momentum names that the market has priced higher relative to book value, implying less of a value orientation.

- Why this aligns with value investing: Value investing focuses on purchasing securities that appear underpriced relative to fundamental measures such as book value, earnings, or cash flow. A high B/M ratio indicates that the stock’s market price is low relative to its accounting value, which is a textbook indicator used by value investors to identify potentially undervalued opportunities.

- Why other interpretations would be incorrect given the described action (conceptual exploration since no other options are listed): If one were to label this as growth investing, the logic would be opposite: growth strategies favor high-priced, growth-oriented stocks with low B/M ratios, not high B/M. If one thought of this as momentum, the emphasis would be on recent price trends rather than contrarian valuation signals; the described long/short construction by B/M is more about valuation means than trend momentum. If there were a market-neutral or market-timing label, those would require additional structure (like hedging against market moves or macro calls) that isn’t specified by the high/low B/M long/short setup.

- Practical consideration about the long/short pair: The long position in high B/M stocks seeks exposure to potential mean reversion to fundamental values, while the short in low B/M stocks reduces exposure to overvalued growth stocks. This combination reinforces a pure value tilt rather than a momentum or growth tilt.

- Summary takeaway: The described strategy corresponds to a value investing style, rooted in buying undervalued assets based on fundamental measures (high book-to-market) and selling overvalued assets (low book-to-market), which is the hallmark of value-oriented strategies.

BU.232.640.W6.SP25 Quiz 3

An investor constructs a portfolio by going long on stocks with high book-to-market ratios and short on stocks with low book-to-market ratios. What style of investing is this?

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