Glamour Stocks And Anchoring On The Changing P/E
Glamour stocks – Over the long-term, value investing as a style outperforms growth (if you’re looking for the evidence to support this statement, you can find it here , here and here ). We’ve known this to be the case for the past five decades. Why then does growth remain a popular strategy? This question formed the basis of a recent study conducted by Anderson, Keith P. and Zastawniak, Tomasz. The results of the study were published at the end of October in a paper entitled, Glamour, Value and Anchoring on the Changing P/E . Citation: Anderson, Keith P. and Zastawniak, Tomasz, Glamour, Value and Anchoring on the Changing P/E (October 23, 2015). Available at SSRN . Glamour, Value and Anchoring on the Changing P/E It has been known since 1960 that a portfolio of low P/E ‘value’ shares will produce better returns than a portfolio of high P/E ‘glamour/growth’ shares (Nicholson, S.F. 1960. Price-earnings ratios. Financial Analysts Journal, 16(4): 43-45.). Many studies have attempted to establish why this is the case but most of these studies have had one key flaw. Indeed, the studies in question have all revolved around the belief that value shares are riskier than glamour shares, which isn’t true. Shleifer and Vishny (Lakonishok, J., Shleifer, A. & Vishny, R. 1994. Contrarian investment, extrapolation, and risk. The Journal of Finance, 49(5): 1541-78.) concluded that value shares are not fundamentally riskier than glamour shares and they went on to give one possible behavioral explanation as to why investors may prefer glamour stocks: they want to appear more prudent. In other words, because glamour shares have been going up in the period before buying, their acquisition is easier to justify. Anderson, Keith P. and Zastawniak, Tomasz argue that a different behavioral explanation is behind the value/glamour split – a well-known feature of investors’ own bounded rationality: anchoring . “Investors may anchor on the P/E ratio currently attached to a stock when they invest in it. Having bought the stock, they expect the P/E to change slowly, if at all. As time goes on, the P/E decile changes, and different prospects for returns attach to each decile. If there is a differential drift in the P/E and hence returns between value and glamour stocks that is not expected by investors, this could account for why glamour investors end up disappointed.” – Glamour, Value and Anchoring on the Changing P/E . (click to enlarge) (click to enlarge) Glamour stocks vs. value Source: Brandes Institute titled, ” T he Role Of Expectations In Value And Glamour Stock Returns. ” Glamour stocks: Three questions With this hypothesis in place, Anderson, Keith P. and Zastawniak, Tomasz focused their research on answering three fundamental questions: Is there justification for the P/Es of value and glamour shares to change at different rates and the fact that value shares outperform glamour shares? What are the observed changes in P/Es and the returns that attach to them, and do investors’ decisions appear to be affected by anchoring ? Can glamour shares’ returns match or exceed those of value shares over any time period? With respect to question one, the study finds that by applying option pricing theory and Merton’s model to prices, and thus P/Es, of value and glamour shares can indeed be expected to move differently. The answer to question two is that glamour shares give three times the returns of value shares if they stay in the same decile, but they have a much greater tendency to move decile, which seems to be the reason behind value’s historical outperformance. Moreover, glamour investors appear to be underestimating the tendency of their shares to change P/E decile by at least 18%. This helps answer question three. Based on the study’s research, glamour investors will be subject to unimpressive returns whatever their time horizon. Glamour stocks: Key findings The major findings of Anderson, Keith P. and Zastawniak, Tomasz’s paper are rather interesting. The paper concludes that the main reason many investors continue to buy glamour shares is because they perceive the high P/E ratios of glamour stocks to be more permanent than they really are. A result of investors’ own behavioural bias of anchoring on the high initial values. However, glamour stocks whose P/E remained elevated throughout the study did outperform value stocks over the same period. Nevertheless, the tendency for the P/E of glamour stocks to change suddenly, and without notice, explains why glamour investors have, and will continue to see poorer returns than those following a value strategy. Disclosure: None