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The Anatomy of value and growth stock returns

Average returns on value and growth portfolios are broken into dividends and three sources of capital gain: (1) growth in book equity, primarily from earnings retention, (2) convergence in price-to-book ratios (P/Bs)from mean reversion in profitability and expected returns, and (3) upward drift in P/B during 1927-2006. The capital gains of value stocks trace mostly to convergence: P/B rises as some value companies become more profitable and their stocks move to lower-expected-return groups. Growth in book equity is trivial to negative for value portfolios but is a large positive factor in the capital gains of growth stocks. For growth stocks, convergence is negative: P/B falls because growth companies do not always remain highly profitable with low expected stock returns. Relative to convergence, drift is a minor factor in average returns..Printed journal

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