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Bridge over ocean
1 November 2007 Financial Analysts Journal Volume 63, Issue 6

The Anatomy of Value and Growth Stock Returns

  1. Eugene F. Fama, PhD
  2. Kenneth R. French

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.

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