Is The Value Spread A Useful Predictor of Returns?

Recent studies have used the value spread as a predictor of aggregate stock returns to construct cash-flow betas that appear to explain the size and value anomalies. Our evidence suggests that the value spread is not a useful predictor of returns. Two related variables, the book-to-market spread — the book-to-market of value stocks minus that of growth stocks — and the market-to-book spread — the market-to-book of growth stocks minus that of value stocks — appear to predict returns but with opposite signs. The value spread combines the information on the book-to-market and market-to-book spreads, and is thus much less useful in predicting returns. Tel: (215)898-1247, fax: (215)898-1280, and email: [email protected]. Address correspondence to: Carol Simon Hall 3-160B, 500 Wilson Blvd, Rochester, NY 14627. Tel: (585)275-3491, fax: (585)273-1140, and email: [email protected]. We acknowledge helpful comments from Mike Barclay, Amit Goyal (WFA discussant), Martin Lettau, John Long, Christopher Polk, Cliff Smith, Tuomo Vuolteenaho, Jerry Warner, and other seminar participants at University of Rochester, Wharton, and Western Finance Association Annual Meetings in Portland. Previous drafts of this paper were circulated under the titles “The value/growth spreads as predictors of returns” and “The value spread as a predictor of returns.” The usual disclaimer applies.