Exploring the transitional behavior among value and growth stocks

Abstract

This study explored the transitional behavior among value and growth stocks based on a balanced panel comprising 520 firms from small-cap S&P 600, mid-cap S&P 400, and large-cap S&P 500 companies during 1999–2008. By employing the nonlinear panel smooth transition regression model, we determined that the annual market-adjusted stock returns were positively related to contemporaneous changes in earnings per share and total asset growth rates and negatively related to the log-transformed 1-year lagged price-to-book equity ratio (LP/B) using the log-transformed 1-year lagged market equity as a transition variable. Our empirical findings are consistent with those by Lakonishok et al. (J Finance 49:1541–1578, 1994), who hypothesized that investors overreact to past firm performance, and Fama and French (Finance Anal J 63:48–58, 2007a, Finance Anal J 63:44–54, 2007b), who discussed the converging P/B ratios caused by the mean reversion in growth, profitability, and expected returns. The three transitional determinants are critical to describing the transitional behavior among value and growth stocks. Moreover, our empirical results indicated that a threshold value of the log-transformed 1-year lagged market equity exists, separating the sample into two groups: value and growth stocks. In addition, the robust test confirmed that the value stocks obtained higher market-adjusted returns during out-of-sample years from 2009 to 2012. These findings have far-reaching implications for institutional investors when creating a profitable and effective investment strategy, and also for CEOs of S&P companies when investing to maximize firm value.