High Minus Low - HML
Categories: Trading, Derivatives
Economists Eugene Fama and Kenneth French have developed a system for evaluating stock returns. It's called the three-factor model.
First factor: market risk.
Second factor: outperformance of small companies versus big companies (also known as SMB, or Small Minus Big).
Third factor: (you probably guessed it) High Minus Low, or HML.
The high and low in this case relate to a company's book-to-market value. Or, said another way, the relationship between the company's book value (its assets minus its liabilities) and its market value (the value of the company as expressed by its stock price).
A high book-to-market stock means that its book value is large compared to its stock value. The market isn't giving a big premium to the value of its underlying assets. If the company sold for scrap, the amount it would get would be relatively close to the amount the stock price suggests it should.
These are generally known as value stocks, meaning that they have a relatively narrow trading range. They aren't going to skyrocket suddenly, but they probably won't swan dive on a given day either. Steady Eddy type stocks.
On the other end of the spectrum, you've got low book-to-market stocks. These don't have many assets to justify their stock price. The situation is more speculative. Investors are in the stock because of what could happen...the company's finances will have to catch up to reality at some point to justify the share price.
These situations are generally called growth stocks. Movement is much more volatile. Up big one day, possibly down big the next.
Fama and French use HML, along with the other two factors, to evaluate portfolio managers, and as an asset pricing model.