Source: Lakonishok, J., Shleifer, A. & Vishny, R. (1994). Journal of Finance 49(5), 1541–1578. (NBER WP #4360, 1993)
TL;DR
Makes the behavioral case for the value premium. Value strategies (high book-to-market, cash-flow-to-price, earnings-to-price, and low past sales growth) outperform "glamour" stocks by roughly 8% per year, and the authors argue this is because investors over-extrapolate past growth — over-pricing glamour and under-pricing value — rather than because value stocks are fundamentally riskier. The value premium does not show up in bad states, undercutting a risk story.
What anomaly it documents
Predictor: value vs. glamour, measured by B/M, cash-flow-to-price (C/P), E/P, and past sales growth (GS). Best single sorts are C/P and combinations of GS with C/P or E/P.
Direction: high-value (cheap, low past growth) stocks earn higher subsequent returns than low-value glamour stocks.
Shape: monotone across deciles; spread persists over each of the 5 post-formation years.
OSAP predictor: value family (BM, CFP, EP, sales growth).
How to construct it
Sample: U.S. NYSE/AMEX stocks, end-of-April 1963 to end-of-April 1990 (formation strategies needing 5 years of past data begin April 1968).
Sort the universe annually into deciles on a value measure; or do a two-way (3×3) sort on GS and C/P (extreme glamour = high GS, low C/P; extreme value = low GS, high C/P).
Hold and track size-adjusted (abnormal) returns over the 5 post-formation years.
Evidence
Book-to-market: glamour (low BM) abnormal return −4.3%/yr vs. value (high BM) +3.5%/yr — a 7.8% per year spread. Cumulative size-adjusted value-minus-glamour ≈ 38.7% over years 1–5; raw 5-year returns 56.5% (glamour) vs 112.1% (value).
Cash-flow-to-price: decile-1 (glamour) −4.9%/yr vs decile-10 (value) +3.9%/yr, an 8.8% spread; cumulative raw spread ≈95.1% over 5 years — C/P alone beats BM.
Two-way GS×C/P and E/P×GS combinations produce the widest, most reliable spreads.
Value does not underperform in bad states (recessions, market declines, worst months), and shows little extra beta or standard deviation — so the premium is hard to attribute to risk.
Why it might work
Investors naively extrapolate past growth: glamour firms' future growth is over-estimated and disappoints, value firms' is under-estimated and surprises positively. The premium is correction of these expectational errors, not risk compensation.
Limitations and risks
Whether value is a true "free lunch" or compensation for hard-to-measure distress risk remains contested (Fama–French, Zhang).
Costs, capacity, and the post-2007 value drought temper the practical premium.
Key references
Lakonishok, J., Shleifer, A. & Vishny, R. (1994) — Contrarian Investment, Extrapolation, and Risk — Journal of Finance
Fama, E. & French, K. (1992) — The Cross-Section of Expected Stock Returns — Journal of Finance
De Bondt, W. & Thaler, R. (1985) — Does the Stock Market Overreact? — Journal of Finance
Provenance: verified/generated from the paper's full text.
