Swedroe On Large-Stock Value Premium

September 19, 2014

Taking a look from another angle.

Recently, we have seen a rise in the level of discussion about whether there is a significant value premium in large-cap stocks. The value premium is the tendency of stocks with low prices relative to measures of their value to outperform stocks with high relative prices. Since large-cap stocks make up about 90 percent of the total global market capitalization, this is an important issue.

Professors Eugene Fama and Kenneth French examined this issue in their 2012 study, “Size, Value, and Momentum in International Stock Returns,” and found that there was a value premium in large-cap stocks of 0.17 percent per month. And while it wasn’t statistically significant—the t-stat was 1.09—a 2 percent per year premium is certainly economically significant. Other studies have found similar results, at least when ranking by price-to-book (P/B) ratio.

It’s also worth noting that the average return spread among large U.S. stocks sorted on P/B ratios was 38 basis points per month from July 1926 to June 1990 (the t-stat was 2.43), but shrank to just 5 basis points per month from July 1990 to June 2013 (the t-stat was 0.26).

That’s consistent with a situation in which arbitrageurs trade away the value premium among large U.S. stocks following the publication of Fama and French’s research prior to (and during) that period. In a 2012 study, however, Fama and French did find an economically large and statistically significant global value premium among small stocks.

Sandro C. Andrade and Vidhi Chhaochharia—authors of the April 2014 study “Is There a Value Premium Among Large Stocks?”—took another, and somewhat different, look at this issue.

While Fama and French use the book-to-market ratio to determine value, Andrade and Chhaochharia use the price-to-earnings (P/E) ratio. And while Fama and French used regional breakdowns (North America, Europe, Japan and Asia-Pacific ex-Japan), Andrade and Chhaochharia used both regional breakdowns and a global pooling approach. Their study covered the 24-year period from July 1990 through June 2013. Following is a summary of their findings:

 

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