Bridge over ocean
29 October 2018 Financial Analysts Journal Volume 74, Issue 4

Fundamentals of Value versus Growth Investing and an Explanation for the Value Trap

  1. Stephen Penman
  2. Francesco Reggiani

Value stocks earn higher returns than growth stocks on average, but a “value” position can turn against the investor. Fundamental analysis can explain this so-called value trap: The investor may be buying earnings growth that is risky. Both the earnings-to-price ratio (E/P) and the book-to-price ratio (B/P) come into play. E/P indicates expected earnings growth, but price in that ratio also discounts for the risk to that growth; B/P indicates that risk. A striking finding emerges: For a given E/P, a high B/P (“value”) indicates higher expected earnings growth—but growth that is risky. This finding contrasts with the standard convention that considers a low B/P to be “growth” with lower risk.

Read the Complete Article in Financial Analysts Journal Financial Analysts Journal CFA Institute Member Content

We're using cookies, but you can turn them off in Privacy Settings. Otherwise, you are agreeing to our use of cookies. Learn more in our Privacy Policy.