Growth or Glamour? Fundamentals and Systematic Risk in Stock Returns

Abstract

The cash flows of growth are particularly sensitive to temporary movements in aggregate stock prices (driven by movements in the equity risk premium), while the cash flows of value are particularly sensitive to permanent movements in aggregate stock prices (driven by market-wide shocks to cash flows.) Thus the high betas of growth with the market's discount-rate shocks, and of value with the market's cash-flow shocks, are determined by the cash-flow fundamentals of growth and value companies. Growth are not merely glamour stocks whose systematic risks are purely driven by investor sentiment. More generally, accounting measures of firm-level risk have predictive power for firms' betas with market-wide cash flows, and this predictive power arises from the behavior of firms' cash flows. The systematic risks of with similar accounting characteristics are primarily driven by the systematic risks of their fundamentals.