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Where to Find Value on the Balance Sheet

Firms with higher book equity relative to market capitalization earn a premium, leading to sorting into value and growth. This sorting implies that any balance sheet additions are risky. This paper provides evidence that what a firm holds on its balance sheet matters, and value occurs with high book-to-market ratios. Each holding relative to firm market capitalization has a risk premium, varying across holdings. Among US firms quarterly for 1980–2016, doubling holdings of cash and receivables relative to market capitalization earn premiums of at least 1%, as does taking on debt. These account for the entire value premium, since physicals, intangibles and payables are not risky. The value premium derives from the composition of the firm’s assets.