Does value beat growth among the stocks of large European firms? In their May 2007 paper entitled “Style Migration in the European Markets”, Antti Pirjetä and Vesa Puttonen compare the performances of simple value and growth styles against MSCI Europe as a benchmark index. They employ a market value-book value ratio (P/BV) to define four style portfolios formed at the end of 2001 and held for five years: (1) median value, consisting of companies with P/BV below the median; (2) median growth, consisting of companies with P/BV above the median; (3) 30-70 value, consisting of companies with P/BV in the bottom 30%; and, (4) 30-70 growth, consisting of companies with P/BV in the top 30%. Using stock return and accounting data for more than 500 of the largest European firms over the period 2001-2006, they conclude that:
- Value outperforms growth during the sample period based on both raw returns and Sharpe ratios, and the median portfolios outperform the 30-70 portfolios. (See the table below.)
- Returns for the four styles are highly correlated, albeit with different magnitudes.
- Evidence suggests that investors avoid the stocks of value firms because of high variability of earnings and low return on invested capital (equity plus debt) compared to growth firms. However, over the five year holding period, value firms substantially improve profitability and return on invested capital, while growth firms do not.
- Stocks that migrate from value to growth offer superior raw and risk-adjusted returns. Value firms with the highest return on invested capital are the most likely to migrate.
The following table, excerpted from the paper, compares mean monthly returns and Sharpe ratios for the four style portfolios defined above. It shows that value beats growth based on both raw returns and Sharpe ratios across the five-year holding period.
In summary, value beats growth among large European stocks during 2002-2006. Value stocks with the highest return on invested capital lead this outperformance.
