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The Performance of Value Vs. Growth Stocks During the Financial Crisis

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The Performance of Value Vs. Growth Stocks During the Financial Crisis MASTER THESIS | 2011 SCHOOL OF MANAGEMENT & GOVERNANCE MSC, BUSINESS ADMINISTRATION – FINANCIAL MANAGEMENT THE PERFORMANCE OF VALUE VS. GROWTH STOCKS DURING THE FINANCIAL CRISIS R.M. HOEKJAN SUPERVISORS PROFESSOR ASSOCIATE PROFESSOR DR. R. KABIR DR. B. ROORDA I | P a g e FOREWORD This thesis is the result of an extensive research executed in order to obtain my Master of Science degree in Business Administration from the University of Twente. Through the course of Corporate Finance, it became clear to me that I wanted to do research that lies within the scope of financial markets, and more specifically the stock markets. However, my interest for financial markets began years ago when acquisition perils around a large Dutch corporate bank took place. I questioned myself how it was possible that a certain shareholder (hedge fund), without a majority of stake in a company, was able to express a great deal of power in order to break-down a bank that seemed to exist for ages (?). While there are so many things to write about and so many things that have been studied, it was difficult to find a topic that dedicated a novelty towards the academic literature within the scope of the stock market. When I started at the University of Twente, the financial crisis was daily news in every newspaper and every news website around the world. Not one day passes by without a newspaper headline or column about problems with money, assets or debt within large financial institutions and conglomerates. I developed a couple of research questions in association with the financial crisis. I also created a question that had nothing to do with the financial crisis in its direct form. It was a question on a topic in which almost every investment book paid attention to in the form of a paragraph or chapter. It was one of those discussions in the financial markets in which investors and analysts did not and do not seem to agree upon. This discussion concerns the performance of value- versus growth stocks. During my first meeting with Prof. Kabir, I discussed my research questions with him. He helped me to form a research question that combined two of the subjects that I was interested in the most; the financial crisis & value and growth stocks. From the start of my thesis, I knew that I did not want to finish my study with a research that was purely based for my thesis and obtaining a masters’ degree. I wanted to extend my knowledge and learn something about it which could provide me the knowledge in my further life and possible future occupation. I wanted to study value and growth stocks in different financial markets and in different countries on a global scale. I did not (wanted to) see my thesis as something that must be done in order to graduate. It must become something I should be proud of on itself and not as a part of something else. Something that express(ed) my interest in financial markets. I | P a g e ACKNOWLEDGEMENT This thesis will probably be the final chapter of my educational journey in either a school or university. My educational dream to obtain a masters’ degree started years ago when I followed an intermediate vocational education programme (MBO) starting in 2006. Most persons are most likely aware that writing a thesis is an interesting but also time-consuming and challenging mission. It is a mission that frequently involves the help and support of a number of people in the writer’s life. Therefore, I would like to acknowledge and thank a number of people that have been instrumental in helping me to finalize my master thesis. First of all, I would like to express my utmost acknowledgement and appreciation towards my parents – André and Joke – for all the motivation, patience, and support they have given me to pursuit my dreams. This thesis would not have been realized without you. Then, my little sister – Cay-Linn – who is my pride and joy, who is the person that inspires me and is my inner strength to work hard, excel, and to accomplish my goals. I would also like to express my gratitude and acknowledgment to Peter Birdsall – chairman of the Wittenborg Business School – and Peter van Oosten – former lecturer at the Wittenborg Business School (May his soul rest in peace) – for providing me the fundaments of knowledge and wisdom in Business Administration in order to succeed at a scientific level of education. My first supervisor, Professor Dr. Rezaul Kabir – Chair of Corporate Finance and Risk Management & director of (International) Business Administration programmes – deserves the greatest acknowledgement and respect. Without your knowledge, wisdom, patience, and support I would not been able to write this thesis as it is written today. You supported me when I was struggling with my thesis in order to get me on the right track again and to improve it. Last but not least, I would also like to express my acknowledgment and respect to my second supervisor; Associate Professor Dr. Berend Roorda, coordinator of the Financial Engineering and Management programme. You gave me the insights and comments which motivated me to look at my thesis from another point of view. The knowledge of both Prof. Kabir and Dr. Roorda regarding the financial markets encouraged me to improve my thesis further. I am most grateful that supervisors were assigned to me that specialized within a specific field of the financial markets themselves since I appreciated their professional insights the most. Robin Hoekjan Enschede, December 6, 2011 II | P a g e This page is left intentionally blank III | P a g e ABSTRACT This study examines the performance of value and growth stocks during the financial crisis of 2007-2010 within the five most influential markets worldwide and on a global scale. Value stocks are those stocks that trade at low prices compared to the fundaments of the company whereby growth stocks are those stocks that trade at high prices compared to the company’s fundaments. In this thesis, portfolios of value and growth stocks are created in the five most influential countries worldwide (United States, Germany, France, China and United Kingdom). Additionally, these five countries are combined to construct global value and growth portfolios. The performance of value and growth stocks are studied by means of value and growth portfolios, which are constructed on the basis of price-to-earnings, price-to-book and price-to-cash flow. The data to calculate these price-multiples are derived from the income statement, balance sheet and statement of cash flow of the companies within the five indices up to four years. Data on stock quotes, quotes of indices, cash dividends and risk-free rates are derived from WSJ.com, Finance.Yahoo.com, and Morningstar.com. To classify stocks to be included in value or growth portfolios, a 30 percent cut-off is used. The performance to study is separated in total return and (systematic) risk. Besides return and risk, price-multiples are studied as well to research whether one price-multiple provide higher return than others. Total return and risk-adjusted measures are studied by means of average and median monthly returns to scrutinize which class of stocks, value or growth, provided the highest return. Finally, a regression analysis is performed to study whether the CAPM and a two-factor model can explain the excess returns made by value and growth portfolios. My findings are as follows; the results obtained from individual countries are invalid to derive statistical meaning and conclusions and are therefore obliterated from discussion. This invalidity can be assignable towards small sample sizes. However, on a global scale, there exist a positive value-growth spread for at least two of the three price-multiples on which value and growth stocks are classified. This means that value stocks provide a higher total return than growth stocks. However, the results are too small and statistically insignificant to insinuate the existence of a global value premium. While value stocks, as compared to growth stocks, also provide a fraction of higher return per unit of risk, as measured by Jensen’s Alpha and Treynor, these results are statistically insignificant as well. Statistical significance could only be found in the first year of the financial crisis and only for Jensen’s Alpha. Second, the study regarding the examination of price-multiples shows that value and growth portfolios classified on P/B does not provide higher returns but are frequently lower compared to portfolios classified on P/E and P/C, which suggests that classification according to P/B is a IV | P a g e poor classification tool for constructing value and growth portfolios. Finally, regression analyses show that both the CAPM and two-factor model can explain the excess returns on global value and growth. Moreover, the estimates on alpha in the CAPM are higher for global value portfolios and equal to the estimates on alpha in the two-factor model. However, the slight improvement on the intercept for global value portfolios by the two-factor model is suggested to be assignable towards the existence of a positive value-growth spread. However, due to the statistically insignificance of a value premium, the difference in intercepts are considerably small. Additionally, the beta coefficients of value stocks are a fraction higher than growth stocks, which is consistent with the general theory that higher betas found in stocks should, by definition, produce higher returns. A higher faction in value betas found during the financial crisis expresses itself in a fraction of higher return. Moreover, this also suggest that the reason behind the fraction of outperformance by value stocks over growth stocks is a compensation of risk rather than the behavioral explanation of investor biases.
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