Growth stocks outperform value stocks over the long term
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Nancy Beneda* is an Assistant Professor of Finance at the University of North Dakota. She specialises in corporate valuation and investing. She obtained her PhD in Finance at St Louis University. Dr Beneda is also a certified public accountant. She worked as a manager at Price Waterhouse in Rhode Island for several years prior to teaching. * University of North Dakota College of Business and Public Administration, Finance Department, PO Box 7096, Grand Forks, ND 58202-7096, USA Tel: ⫹1 701 777 4690; Fax: ⫹1 701 777 2396; e-mail: [email protected]
Abstract Previous studies have generally found that returns on growth stocks, or stocks with high price-to-earnings (P/E) ratios, often lag behind those of value stocks, or stocks with low-P/E ratios. This study examines the long-term (up to 18 years) performance of growth stocks versus value stocks when a buy-and-hold strategy is adhered to. The study examines the performance of growth versus value stocks of portfolios created during the period 1983–7. The findings of this study indicate that the long-term performance (14⫹ years) of growth stocks is higher than the long-term performance of value stocks for portfolios created during the years included in this study. After only five years, however, the growth stocks lagged behind the value stocks. These results tend to support the efficient market hypothesis. Keywords: growth stocks; value stocks; stock performance; price-earnings ratio; efficient market hypothesis; earnings growth
Introduction The efficient market hypothesis suggests that the price-earnings (P/E) ratio shows what investors think about the future growth opportunities of the company. Thus theory suggests that growth stocks or stocks perceived to be growth stocks tend to have P/E ratios higher than average. Prior studies have found that high long-term forecasted growth and high current earnings growth tend to be associated with high-P/E ratios (Zarowin, 1990; Cho, 1994; Fairfield, 1994; Penman, 1996). A number of academic studies, however, provide evidence to dispute this theory. Previous research has found
112
Journal of Asset Management
that value stocks (low-P/E stocks) are actually more attractive than growth stocks (high-P/E stocks). The findings of these studies indicate that low-P/E securities tend to outperform high-P/E stocks. Lakonishok et al. (1994) examine five-year holding periods and confirm that the returns on growth stocks lag behind the return on stocks that have low-P/E ratios over five-year horizons. Basu (1977) finds that during the 14-year period April 1957 to March 1971, the low-P/E portfolios, on average, earned higher rates of return than the high-P/E portfolios. The indication of these studies is that high-P/E stocks are overvalued, a
Vol. 3, 2, 112–123
䉷 Henry Stewart Publications 1470-8272 (2002)
Growth stocks outperform value stocks
violation of the efficient market hypothesis. That is to say, investors who are seeking capital gains and future growth of earnings, may irrationally place too high a premium on the p
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