Investor expectations and the performance of value stocks versus growth stocks - Why value stocks outperform growth stocks

The difference in performance between the value stock portfolio style and the growth stock portfolio style appears to be due in part to forecasters placing too much importance on trends in the recent past. Value stocks have tended to outperform growth stocks over a fourteen-year period on both a total return basis and a risk-adjusted basis. The difference in performance between value stocks and growth stocks, as defined by the price/earnings ratio and the price-to-cash now per share ratio, appears to be strongly associated with their respective earnings surprises, in which analysts generally underestimate the EPS of value stocks and overestimate the EPS of growth stocks. This result reflects the tendency for investors and analysts to extrapolate the trend of past EPS into the future, yet the pattern of annual changes in EPS resembles a random walk or a mean reversion tendency. In addition, value stocks, regardless of their capitalization, generally outperformed comparable-size growth stocks.