The Role Of Growth In Long Term Investment Returns

Abstract

<p class="MsoBodyText2" style="margin: 0in 0.5in 0pt;"><span style="font-size: 10pt;"><span style="font-family: Times New Roman;">Stocks with a high valuation compared to fundamental values imply a high growth rate, yet these stocks have typically under-performed in subsequent years supporting Lakonishok, Shleifer and Vishney's (1994) contrarian investment strategies. The precise definition of growth and subtle differences of measuring growth are explored in assessing the role of growth in long-term investment decisions and stock valuation.<span style="mso-spacerun: yes;">  </span>Results from a later period and with additional tests than employed by LSV indicate that growth is a primary valuation factor, and valuation measures such as E/P and B/M, are imperfect proxies for expected growth.<span style="mso-spacerun: yes;">  </span>Growth appears mean reverting, but investors do not seem able to discern changes in growth rates and this miss-specification of expected growth may help explain the superiority of value versus growth strategies. In addition, investors’ naïve extrapolations of past growth provide explanatory power in future holding period returns.<span style="mso-spacerun: yes;">  </span></span></span></p>

What Explains the Asset Growth Effect in Stock Returns?

“…Cooper, Gulen, and Schill (2008) refer to this empirical fact as the "asset growth effect." A number of papers observe a similar negative relationship between various measures of firm asset growth and subsequent stock returns (see Fairfield, Whisenant, and Yohn, 2003;Titman, Wei, and Xie, 2004;and Broussard, Michayluk, and Neely, 2005). 1 There is a growing literature that provides theoretical support for a negative correlation between the growth in firm assets and subsequent returns (see Cochrane, 1991Cochrane, ,1996Berk, Green, and Naik 1999;Gomes, Kogan, and Zhang, 2003;and Li, Livdan, Zhang, 2008).…”

The Asset Growth Effect and Investor Protection in Emerging Markets: The Role of the Global Financial Crisis

“…Titman, Wei, and Xie (2004) find that an abnormal increase in firms' capital investment is associated with lower stock returns for five subsequent years and identify this relationship as a separate anomaly in addition to the long-term return reversal and secondary equity issue anomalies. Broussard, Michayluk, and Neely (2005) use data on US firms for the pre-internet period (1981)(1982)(1983)(1984)(1985)(1986)(1987)(1988)(1989)(1990)(1991)(1992)(1993)(1994)(1995) and different measures of growth, including asset growth as an indicator of the long-term trend in the success of a firm. Their results show an inverse relationship between past growth rates and future growth rates and holding period returns.…”

The relationship between asset growth and the cross-section of stock returns

“…First, a recent study by Cooper, Gulen and Schill (CGS) (2008) reports a very strong association between asset growth and US stock returns. While several prior studies examine various components of asset growth (Broussard et al, 2005;Carlson et al, 2004;Hirshleifer et al, 2004;Lakonishok et al, 1994), CGS (2008) are the first to examine total asset growth. They argue that total asset growth is a better predictor of returns than any single component of growth because it synergistically benefits from the predictability of all sub-components.…”