Value and growth stocks in Brazil: risks and returns for one- and two-dimensional portfolios under different states of the economy

For empirical purposes, value stocks are usually defined as those traded at low price-to-earnings ratios (stock prices divided by earnings per share), low price-to-book ratios (stock prices divided by book value per share) or high dividend yields (dividends per share divided by stock prices). Growth stocks, on the other hand, are traded at high price-to-earnings ratios, high price-to-book ratios or low dividend yields. The academic research so far produced, international and Brazilian alike, shows that value stocks outperform growth stocks, challenging the Efficient Market Hypothesis, which states that the market prices of traded stocks are the best estimate of their intrinsic values. Most studies use a single ratio to sort stocks on percentiles; risks (generally defined as beta or standard-deviations) and returns are then calculated for the resulting value and growth portfolios. In the present article, we aim to further contribute to the growing literature on the field by building portfolios sorted by the price-to-earnings and price-to-book ratios alone and by a combination of both in order to assess value and growth stocks’ risks and returns on the Brazilian stock market from the years 1989 to 2009. Furthermore, our risk analysis departs from conventional risk concepts, as we not only test for beta: portfolios’ returns are measured in different states of the economy. Results support a pervasive value premium in the Brazilian stock market. Risk analysis shows that this premium holds at every state of the economy analyzed, suggesting that value stocks are indeed less risky. Beta proved not to be a satisfactory risk measure. Portfolios sorted by the price-to-earnings ratio yielded the best results.