The Anatomy of Value and Growth Stock Returns
Eugene F. Fama
University of Chicago - Finance
Kenneth R. French
Tuck School of Business at Dartmouth; National Bureau of Economic Research (NBER)
CRSP Working Paper
We break average returns on value and growth portfolios into dividends and three sources of capital gain, (i) growth in book equity primarily due to earnings retention, (ii) convergence in price-to-book ratios (P/B) due to mean reversion in profitability and expected returns, and (iii) upward drift in P/B during 1927-2006. The capital gains of value stocks trace mostly to convergence: P/B rises as some value firms become more profitable and move to lower expected return groups. Growth in book equity is trivial to negative for value portfolios, but it is a large positive factor in the capital gains of growth stocks. For growth stocks, convergence is negative: P/B falls because growth stocks do not always remain highly profitable with low expected returns. Relative to convergence, drift is a minor factor in average returns.
Number of Pages in PDF File: 25
JEL Classification: G12
Date posted: September 28, 2005
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