A new study suggests that the book-to-market ratio—long used by value investors to gauge the value of a company– should be replaced by the retained earnings-to-market ratio due to its more sustained predictive power. This according to a recent AAII article.

The study’s authors argue that retained earnings, which include past earnings, “average out inconsistencies like accruals and one-time items,” which insulates it from “individual year accounting effects.” Contributed capital, a component of book value, “merely reflects the fact that investors put capital into a company. It does not provide any insights about a company’s risk, only willingness on the part of investors to bear the risk.”

The study found that the book-to-market ratio showed predictive power regarding the “cross-section  of returns” for the period from June 1964 through June 1990, but this decreased after 1990 due to a “change in the composition of public firms” while the retained earnings-to-market maintained its predictive power. The article added: “Retained earnings-to-price also works as a good proxy for a company’s underlying earnings yield” since it also reflects past accumulated earnings.