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

See all articles by Stephen H. Penman

Stephen H. Penman

Columbia University - Columbia Business School, Accounting, Business Law & Taxation; Bocconi University

Francesco Reggiani

Free University of Bozen-Bolzano

Date Written: August 14, 2018

Abstract

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.

Suggested Citation

Penman, Stephen H. and Reggiani, Francesco, Fundamentals of Value vs. Growth Investing and an Explanation for the Value Trap (August 14, 2018). Financial Analysts Journal, Fourth Quarter 2018, Vol. 74, No. 4: 103–119. , Available at SSRN: https://ssrn.com/abstract=2494412 or http://dx.doi.org/10.2139/ssrn.2494412

Stephen H. Penman (Contact Author)

Columbia University - Columbia Business School, Accounting, Business Law & Taxation ( email )

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Bocconi University ( email )

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Italy

Francesco Reggiani

Free University of Bozen-Bolzano ( email )

Sernesiplatz 1
Bozen-Bolzano, BZ 39100
Italy

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