High Quality
Open the downloaded document, and select print from the file menu (PDF reader required).
THEJOURNALOFFINANCE.VOL.XLIX,NO.5.DECEMBER1994
ContrarianInvestment,Extrapolation,andRisk
JOSEFLAKONISHOK,ANDREISHLEIFER,
and
ROBERTW.VISHNY*
ABSTRACT
Formanyyears,scholarsandinvestmentprofessionalshavearguedthatvaluestrategiesoutperformthemarket.Thesevaluestrategiescallforbuyingstocksthathavelowpricesrelativetoearnings,dividends,bookassets,orothermeasuresoffundamentalvalue.Whilethereissomeagreementthatvaluestrategiesproducehigherreturns,theinterpretationofwhytheydosoismorecontroversial.Thisarticleprovidesevidencethatvaluestrategiesyieldhigherreturnsbecausethesestrategiesexploitthesuboptimalbehaviorofthetypicalinvestorandnotbecausethesestrategiesarefundamentallyriskier.
FOR
MANY
YEARS,SCHOLARSndinvestmentprofessionalshavearguedthatvaluestrategiesoutperformthemarket(GrahamandDodd(1934)andDreman(1977)).Thesevaluestrategiescallforbuyingstocksthathavelowpricesrelativetoearnings,dividends,historicalprices,bookassets,orothermeasuresofvalue.Inrecentyears,valuestrategieshaveattractedacademicattentionaswell.Basu(1977),Jaffe,Keim,andWesterfield(1989),Chan,Hamao,andLakonishok(1991),andFamaandFrench(1992)showthatstockswithhighearnings/priceratiosearnhigherreturns.DeBondtandThaler(1985,1987)arguethatextremelosersoutperformthemarketoverthesubsequentseveralyears.Despiteconsiderablecriticism(Chan(1988)andBallandKothari(1989)),theiranalysishasgenerallystooduptothetests(Chopra,Lakonishok,andRitter(1992)).Rosenberg,Reid,andLanstein(1984)showthatstockswithhighbookrelativetomarketvaluesofequityoutperformthemarket.Furtherwork(Chan,Hamao,andLakonishok(1991)
*
LakonishokisfromtheUniversityofIllinois,ShleiferisfromHarvardUniversity,andVishnyisfromtheUniversityofChicago.WeareindebtedtoGilBeebower,FischerBlack,StephenBrown,
K.
C.Chan,LouisChan,EugeneFama,KennethFrench,BobHaugen,JayRitter,ReneStulz,andtwoanonymousrefereesforhelpfulcommentsandtoHanQuforoutstandingresearchassistance.ThisarticlehasbeenpresentedattheBerkeleyPrograminFinance,UniversityofCalifornia(Berkeley),theCenterforResearchinSecuritiesPricesConference,theUniversityofChicago,theUniversityofIllinois,theMassachusettsInstituteofTechnology,theNationalBureauofEconomicResearch(AssetPricingandBehavioralFinanceGroups),NewYorkUniversity,PensionsandInvestmentsConference,theInstituteforQuanti-tativeResearchinFinance(UnitedStatesandEurope),SocietyofQuantitativeAnalysts,StanfordUniversity,theUniversityofToronto,andTelAvivUniversity.TheresearchwassupportedbytheNationalScienceFoundation,BradleyFoundation,RussellSageFoundation,theNationalBureauofEconomicResearchAssetManagementResearchAdvisoryGroup,andtheNationalCenterforSupercomputingApplications,UniversityofIllinois.
1541
1542
TheJournalofFinance
andFamaandFrench(1992))hasbothextendedandrefinedtheseresults.Finally,Chan,Hamao,andLakonishok(1991)showthatahighratioofcashflowtopricealsopredictshigherreturns.Interestingly,manyoftheseresultshavebeenobtainedforboththeUnitedStatesandJapan.Certaintypesofvaluestrategies,then,appeartohavebeatenthemarket.Whilethereissomeagreementthatvaluestrategieshaveproducedsupe-riorreturns,theinterpretationofwhytheyhavedonesoismorecontrover-sial.Valuestrategiesmightproducehigherreturnsbecausetheyare
contrar-ian
to"naive"!strategiesfollowedbyotherinvestors.Thesenaivestrategiesmightrangefromextrapolatingpastearningsgrowthtoofarintothefuture,toassumingatrendinstockprices,tooverreactingtogoodorbadnews,ortosimplyequatingagoodinvestmentwithawell-runcompanyirrespectiveofprice.Regardlessofthereason,someinvestorstendtogetoverlyexcitedaboutstocksthathavedoneverywellinthepastandbuythemup,sothatthese"glamour"stocksbecomeoverpriced.Similarly,theyoverreacttostocksthathavedoneverybadly,oversellthem,andtheseout-of-favor"value"stocksbecomeunderpriced.Contrarianinvestorsbetagainstsuchnaiveinvestors.Becausecontrarianstrategiesinvestdisproportionatelyinstocksthatareunderpricedandunderinvestinstocksthatareoverpriced,theyoutperformthemarket(seeDeBondtandThaler(1985)andHaugen(1994)).
An
alternativeexplanationofwhyvaluestrategieshaveproducedsuperiorreturns,arguedmostforcefullybyFamaandFrench(1992),isthattheyare
fundamentallyriskier.
Thatis,investorsinvaluestocks,suchashighbook-to-marketstocks,tendtobearhigherfundamentalriskofsomesort,andtheirhigheraveragereturnsaresimplycompensationforthisrisk.ThisargumentisalsousedbycriticsofDeBondtandThaler(Chan(1988)andBallandKothari(1989))todismisstheiroverreactionstory.Whethervaluestrategieshaveproducedhigherreturnsbecausetheyarecontrariantonaivestrategiesorbecausetheyarefundamentallyriskierremainsanopenques-tion.
In
thisarticle,wetrytoshedfurtherlightonthetwopotentialexplana-tionsforwhyvaluestrategieswork.Wedosoalongtwodimensions.First,weexaminemorecloselythepredictionsofthecontrarianmodel.
In
particular,onenaturalversionofthecontrarianmodelarguesthattheoverpriced
glamourstocks
arethosewhich,first,haveperformedwellinthepast,andsecond,areexpectedbythemarkettoperformwellinthefuture.Similarly,theunderpricedout-of-favoror
valuestocks
arethosethathaveperformedpoorlyinthepastandareexpectedtocontinuetoperformpoorly.Valuestrategiesthatbetagainstthoseinvestorswhoextrapolatepastperformancetoofarintothefutureproducesuperiorreturns.
In
principle,thisversionofthecontrarianmodelistestablebecausepastperformanceandexpectationoffutureperformancearetwodistinctandseparatelymeasurablecharacteris-ticsofglamourandvalue.
In
thisarticle,pastperformanceismeasuredusing
1
Whatwecall"naivestrategies"arealsosometimesreferredtoas"popularmodels"(Shiller(1984))and"noise"(Black(1986)).
ContrarianInvestment,Extrapolation,andRisk
1543
informationonpastgrowthinsales,earnings,andcashflow,andexpectedperformanceismeasuredbymultiplesofpricetocurrentearningsandcashflow.Weexaminethemostobviousimplicationofthecontrarianmodel,namelythatvaluestocksoutperformglamourstocks.Westartwithsimpleone-variableclassificationsofglamourandvaluestocksthatrelyinmostcasesonmeasuresofeitherpastgrowthorexpectedfuturegrowth.Wethenmoveontoclassificationsinwhichglamourandvaluearedefinedusingbothpastgrowthandexpectedfuturegrowth.
In
addition,wecomparepast,expected,andfuturegrowthratesofglamourandvaluestocks.Ourversionofthecontrarianmodelpredictsthatdifferencesinexpectedfuturegrowthratesarelinkedtopastgrowthandoverestimateactualfuturegrowthdifferencesbetweenglamourandvaluefirms.Wefindthatawiderangeofvaluestrategieshaveproducedhigherreturns,andthatthepatternofpast,expected,andactualfuturegrowthratesisconsistentwiththecontrarianmodel.Thesecondquestionweaskiswhethervaluestocksareindeedfundamen-tallyriskierthanglamourstocks.Tobefundamentallyriskier,valuestocksmustunderperformglamourstockswithsomefrequency,andparticularlyinthestatesoftheworldwhenthemarginalutilityofwealthishigh.Thisviewofriskmotivatesourtests.Welookatthefrequencyofsuperior(andinferior)performanceofvaluestrategies,aswellasattheirperformanceinbadstatesoftheworld,suchasextremedownmarketsandeconomicrecessions.Wealsolookatthebetasandstandarddeviationsofvalueandglamourstrategies.Wefindlittle,ifany,supportfortheviewthatvaluestrategiesarefunda-mentallyriskier.Ourresultsraisetheobviousquestionofhowthehigherexpectedreturnsonvaluestrategiescouldhavecontinuedifsuchstrategiesarenotfundamen-tallyriskier?Wepresentsomepossibleexplanationsthatrelybothonbehav-ioralstrategiesfavoredbyindividualinvestorsandonagencyproblemsplaguinginstitutionalinvestors.Thenextsectionofthearticlebrieflydiscussesourmethodology.SectionIIexaminesavarietyofsimpleclassificationschemesforglamourandvaluestocksbasedonthebook-to-marketratio,thecashflow-to-priceratio,theearnings-to-priceratio,andpastgrowthinsales.SectionIIshowsthatallofthesesimplevaluestrategieshaveproducedsuperiorreturnsandmotivatesoursubsequentuseofcombinationsofmeasuresofpastandexpectedgrowth.Section
III
thenexaminestheperformanceofvaluestrategiesthataredefinedusingbothpastgrowthandcurrentmultiples.Thesetwo-dimensionalvaluestrategiesoutperformglamourstrategiesbyapproximately10to11percentperyear.Moreover,thesuperiorperformanceofvaluestocksrelativetoglamourstockspersistswhenwerestrictourattentiontothelargest50percentorlargest20percentofstocksbymarketcapitalization.SectionIVprovidesevidencethatcontrarianstrategiesworkbecausetheyexploitexpec-tationalerrorsimplicitinstockprices.Specifically,thedifferencesinex-pectedgrowthratesbetweenglamourandvaluestocksimplicitintheir
Add a Comment