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Is There Existence of a Value Premium Among Large Stocks?

Last Updated on 10 February, 2024 by Rejaul Karim

Is There a Value Premium Among Large Stocks?” is a research paper penned by Sandro C. Andrade and Vidhi Chhaochharia that revisits the findings of Fama and French (2012) who argued against a significant global value premium among large stocks.

The authors utilise two methodological changes: shifting from price-to-book to price-to-earnings ratios for stock sorting, and applying global instead of regional value breakpoints. The alterations reveal an increasing spread in return from 17 to 64 basis points per month for the top and bottom 30% stocks.

Findings suggest that the value premium is a significant economic phenomenon, not confined to small stocks, urging that researchers consider factors beyond price-to-book when exploring the value effect.

Abstract Of Paper

Fama and French (2012) find no significant global value premium among large stocks. Two simple departures from their methodology restore such premium: sorting stocks on price-to-earnings rather than price-to-book ratios, and using global rather than regional value breakpoints. The resulting global value premium among large stocks, measured as the return spread between top 30% and bottom 30% stocks, increases from 17 (t-stat=1.09) to 64 (t-stat=2.61) basis points per month. Using price-to-earnings computed from earnings estimates rather than historical earnings further sharpens the global value effect among large stocks. Not confined to small stocks, the value premium remains a highly economically significant phenomenon. Because valuation ratios are not interchangeable, researchers should consider looking beyond price-to-book when studying, or controlling for, the value effect.

Original paper – Download PDF

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Author

Sandro C. Andrade
University of Miami – Department of Finance

Vidhi Chhaochharia
University of Miami – Department of Finance

Conclusion

In conclusion, “Is There a Value Premium Among Large Stocks?” presents a significant reconsideration of past studies that overlooked a noticeable global value premium among large stocks.

The revised methodology, relying on price-to-earnings for stock sorting and global value breakpoints, reinstates the global value premium, reflecting an appreciable increase in the monthly return spread. Additionally, utilizing earnings estimates rather than historical earnings further illuminates the global value effect among large stocks.

This research, hence, emphasizes robustly that the value premium persists as an economically significant element, not limited to small stocks. It also suggests that valuation ratios are not mutually substitutable, underlining the need for researchers to broaden their focus beyond price-to-book when examining the value effect.

Related Reading:

Accruals, Cash Flows, and Operating Profitability in the Cross Section of Stock Returns

Market Timing with Aggregate and Idiosyncratic Stock Volatilities

FAQ

What is the main contribution of the research paper “Is There a Value Premium Among Large Stocks?” by Sandro C. Andrade and Vidhi Chhaochharia?

The main contribution of the research paper is to challenge the findings of Fama and French (2012), who argued against a significant global value premium among large stocks. The authors introduce two methodological changes—shifting from price-to-book to price-to-earnings ratios for stock sorting and applying global instead of regional value breakpoints. These changes reveal a substantial and economically significant global value premium among large stocks, urging a reconsideration of the factors influencing the value effect.

How do the methodological changes in the paper impact the observed value premium among large stocks?

The methodological changes, specifically sorting stocks on price-to-earnings ratios and using global value breakpoints, lead to a restoration of the global value premium among large stocks. The return spread between the top 30% and bottom 30% stocks increases significantly, from 17 to 64 basis points per month. These changes emphasize the importance of methodology in capturing the value premium and suggest that the choice of valuation ratios is crucial in understanding the dynamics of the value effect.

What does the paper suggest about the economic significance of the value premium among large stocks?

The findings of the paper underscore that the value premium among large stocks is not only present but is also economically significant. The increased return spread resulting from the methodological changes indicates that the value premium is a robust and noteworthy phenomenon, challenging the previous notion that it is not prevalent among large stocks. This has implications for investors and researchers, highlighting the need to consider a broader set of factors, beyond price-to-book, when exploring and understanding the value effect.

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