A South African look at value vs. growth investing, extrapolation, and risk

Abstract

Contrarian investment is a well-documented strategy that may be able to earn the investor superior returns. The theory holds that stocks that have had historically poor performance should be invested in, while stocks that have had superior past performance are sold. These poor past performers are considered value stocks, classified by their high book-to-market, earnings yield, dividend yield and cash flow-to-price ratios. They have low expected future cash flow growth, and tend to have low earnings. Reasons suggested for the success of contrarian investing include judgment biases, naive investors extrapolating past performance too far into the future, value stocks are riskier than growth, and well-known firms are associated with well-managed firms. CAPM along with multivariate regressions and the three-factor model are considered in this dissertation. Data comes from Findata@Wits. Topics such as behavioural finance are dealt with. Consideration of past literature is looked at - similarities and differences in results, along with comparable methods and markets. The size and book-to-market variables appear to be the best explanatory variables, proving that whether equally or value weighted, value will still outperform growth in terms of excess returns. The earnings yield explains stock returns the least.