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One of the most contentious issues of discussion among researchers for many years has been
the superior performance of ‘value stocks’1 over ‘growth stocks or glamor stocks’2, which is in
conflict with the previously championed hypothesis of efficient markets.3 An extensive body
of empirical research can be identified in this context which dates back to late 1960s and
1970s. For example, Breen (1968), Flugel (1968), Basu (1977 and 1983), Jaffe et al. (1989), and
Chan et al. (1991) show that stocks with low P/E ratios earn higher returns compared to
stocks with high P/E ratios. De Bondt and Thaler (1985 and 1987) argue that extreme losers
in a particular year outperform the market over the subsequent several years. Some of the
more recent works include Jaffe et al. (1989), Fama and French (1992, 1993, 1996 and 1998),
Lakonishok et al. (1994), La Porta (1996), Cai (1997), Daniel and Titman (1997) and Gregory
et al. (2001). More than one explanation has been introduced in these studies to explain the
superiority of ‘value’ stocks over ‘glamor’ stocks. The principal argument made in these
studies was that investors tend to overreact to the past performance of the firms thereby
pricing the growth stocks too high and value stocks too low. Subsequent to these overreactions,
the expensive growth stocks more often than not fail to fulfill the expectations of their
investors and produce low returns, while the cheap value stocks produce high returns. Another
explanation for ‘value premium’4 was given by Fama and French (1992, 1993 and 1996).
Working with the US stocks over the period 1963 to 1990, they confirmed the existence of
value premium, but claimed that differences in the performance between value and growth
stocks was due to the fact that value stocks are more risky. The claim of Fama and French
study was however challenged by Lakonishok et al. (1994) who suggested that value strategies
yield higher returns because they exploit the suboptimal behavior of the typical investor and
not because they are fundamentally riskier. The existence of value premium was confirmed
not only in the US markets, but also in the other prominent markets of the world. Fama and
French (1998) confirmed the existence of value premium in 12 out of 13 major markets
worldwide. Cai (1997) also documented the existence of value premium for the Tokyo stock
market. Cohen et al. (2003) show that the expected value premium is higher when the spread
in the book-to-market ratio is wider. Another explanation of the superiority of value stocks
is attributed to the bias indicated by research design such as survivorship bias in the selection
of data (Lo and MacKinlay, 1990; and Kothari et al., 1995).
There is thus an agreement amongst the researchers that value stocks have produced a
premium over growth stocks over time and cross-sections. Our attempts in this paper have
been to find whether or not value premium is traceable in the Indian stock market and to find
its magnitude and pattern over various holding periods. We also tried to find answers to the
fundamental questions like—Are return-differentials from value investing statistically
significant? If so, can they be ascribed to differences in risk? We formed portfolios of stocks
classified as ‘value’ or ‘growth’ based on the ‘price-to-book’ ratio of stocks and tracked their
performance over various holding periods.
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