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Abstract
The main objective of this paper is to compare the performance of value stocks and growth stocks in the U.S. market using the enterprise value (EV) of each firm. Four portfolios are formed, and the consistency of the performance of each portfolio is examined under different market conditions. Changes in performance are also be tested using returns on equity (ROE) as a proxy of future earnings. Finally, the impact of firm size on performance is investigated. Using the stocks of 4,952 firms for the period 15 years from January 2, 1999 to December 31, 2014, it has been shown that the value stocks outperform the growth stocks. These results are not changed with different holding periods. The requirement of ROE above 5 percent has the impact on the performance of growth stocks. In terms of firm size, it appears small firms are more profitable than large firms.
JEL classification numbers: G11, G14
Keywords: Value Investing Strategy, Value Stock, Growth Stock, Enterprise Value
1 Introduction
Various investment strategies have been developed and used by professional investors to earn high returns in the stock market. Among them, value investment strategy and growth investment strategy have probably been most popular in the investment community around the world. The difference between two strategies comes from different views on value ratios, such as Book/Market (B/M) ratio and Earning/Price (E/P) ratio. Value investors look for stocks with high value ratios because they believe that these stocks have strong current fundamentals for the book value and earnings power but incorrectly undervalued by the market now. Hence, share prices are expected to rise in the future when the valuation error is corrected by the market. Growth investors, however, buy stocks with future growth potential which can lead to a significant increase in stock prices in the long run. Growth stocks are expected to be currently trading at prices higher than their intrinsic value because of the growth potential and, accordingly, their value ratios are generally low. The idea behind the growth strategy is the efficient market hypothesis which states that the current stock price reflects all the information available about the firm and, therefore, the current price is most reasonable at that point of time.
Clearly, there are arguments on...