Fundamentals of Value vs. Growth Investing and an Explanation for the Value Trap
Financial Analysts Journal, Fourth Quarter 2018, Vol. 74, No. 4: 103–119.
37 Pages Posted: 12 Sep 2014 Last revised: 7 Dec 2018
Date Written: August 14, 2018
Value stocks earn higher returns than growth stocks on average, but a “value” position can turn against the investor. Fundamental analysis can explain this so-called value trap: the investor may be buying earnings growth that is risky. Both E/P and B/P, come into play: E/P (or P/E) indicates expected earnings growth, but price in that ratio also discounts for the risk to that growth; B/P indicates that risk. A striking finding emerges: for a given E/P, high B/P (“value”) is indicates higher expected earnings growth, but growth that is risky. This contrasts with the standard labeling that nominates low B/P as “growth” with lower risk.
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