The Anatomy of Value and Growth Stock Returns

We break average returns on value and growth portfolios into dividends and three sources of capital gain, (i) reinvestment of earnings, (ii) convergence in price-to-book ratios (P/B) due to mean reversion in profitability and expected returns, and (iii) upward drift in P/B during 1926-2003. The capital gains of value stocks trace mostly to convergence: P/B rises as some value firms become more profitable and move to lower expected return groups. In contrast, reinvestment, which is trivial to negative for value portfolios, dominates the capital gains of growth stocks. For growth stocks, convergence is negative: P/B falls because growth stocks do not always remain highly profitable with low expected returns.

Fama, Eugene F. and French, Kenneth R., "The Anatomy of Value and Growth Stock Returns" (September 2005). CRSP Working Paper Available at SSRN: http://ssrn.com/abstract=806664