Chapter 4
Value and Growth Investing
In the last chapter, we searched for a small-cap premium using a variety of data sets and time periods. There is a corresponding value premium that is said to reward investment in value stocks relative to growth stocks. Value stocks are usually identified as those with relatively low market prices to book values. This chapter will investigate whether value stocks do offer a premium over growth stocks.
For the past two decades, many investment advisors have divided their U.S. stock allocations along the value-growth dimension. Since portfolios are also typically divided by size, many of these same advisors divide portfolios into four quadrants called style boxes: large-cap value and growth and small-cap value and growth. Two influential papers by Eugene Fama and Kenneth French present evidence that book-to-market and size explain a large portion of the cross-section variation of stocks, so it makes sense to divide portfolios along these two dimensions.1 We will examine the chief characteristics of value and growth indexes, beginning with a description of large-cap value and growth stocks.
