Abstract
For empirical purposes, value stocks are usually defined as those traded at low price-to-earnings ratios (stock prices divided by earnings per share), low price-to-book ratios (stock prices divided by book value per share) or high dividend yields (dividends per share divided by stock prices). Growth stocks, on the other hand, are traded at high price-to-earnings ratios, high price-to-book ratios or low dividend yields. Academic research so far produced, international and Brazilian alike, shows that value stocks outperform growth stocks, challenging the Efficient Market Hypothesis, which states that the market prices of traded stocks are the best estimate of their intrinsic values. Most studies use a single ratio to sort stocks on percentiles; risks (generally defined as beta or standard deviations) and returns are then calculated for the resulting value and growth portfolios. In the present paper, we aim to further contribute to the growing literature on the field by applying a method not previously tested on the Brazilian market. We build portfolios sorted by the price-to-earnings and price-to-book ratios alone and by a combination of both in order to assess value and growth stocks' risks and returns on the Brazilian stock market between 1989 and 2009. Furthermore, our risk analysis may be regarded as the paper's main contribution, since its approach departs from conventional risk concepts, as we not only test for beta: portfolios' returns are measured under different economic conditions. Results support a pervasive value premium in the Brazilian stock market. Risk analysis shows that this premium holds under every economic condition analyzed, suggesting that value stocks are indeed less risky. Beta proved not to be a satisfactory risk measure. Portfolios sorted by the price-to-earnings ratio yielded the best results.
Highlights
Academic research on Value Investing seemed to lie dormant well into the 1990s, in spite of the pioneering study by Basu (1977), the half-century-old teachings of Benjamin Graham – who, on 1934, laid bare the foundations of the discipline (GRAHAM AND DODD, 1934) – and the remarkable investment stories of many of his followers, notably Berkshire Hathaway’s Warren Buffett, whose 24-year-long investment history produced a 20.3% compounded growth (BUFFETT, 2010)
Risk analysis shows that this premium holds under every economic condition analyzed, suggesting that value stocks are less risky
Part of the blame can be attributed to the intellectual dominance of the Efficient Markets School (EMS), whose models and theories became the paradigms of choice of the academic community
Summary
Academic research on Value Investing seemed to lie dormant well into the 1990s, in spite of the pioneering study by Basu (1977), the half-century-old teachings of Benjamin Graham – who, on 1934, laid bare the foundations of the discipline (GRAHAM AND DODD, 1934) – and the remarkable investment stories of many of his followers, notably Berkshire Hathaway’s Warren Buffett, whose 24-year-long investment history produced a 20.3% compounded growth (BUFFETT, 2010). The EMS propounds that agents are rational, the market prices of tradable securities are the best estimate of their intrinsic values and higher returns always entail higher risks Value Investing’s practitioners regard markets as inherently inefficient: investors often bid market prices away from intrinsic values, allowing for the purchase of undervalued securities, which tend to produce better returns in the long run (see GREENWALD ET AL., 2001). Rationality is limited, for market agents are human beings, psychologically and neurologically unfit for investing (see BARBERIS AND THALER, 2003 and ZWEIG, 2007), who from time to time fall victim to market fads (see KINDLEBERGER, 2005 and CHANCELLOR, 2000)
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