- 1Value stocks outperform "glamour" stocks by 10-11% per year in their sample
- 2The outperformance is NOT due to higher risk—value stocks are actually less risky
- 3Investors extrapolate past growth too far into the future, overpaying for glamour
- 4Growth rates mean-revert: today's fast growers become tomorrow's average performers
- 5This behavioral explanation challenges the Fama-French risk-based view
#The Paper at a Glance
Title: Contrarian investment, extrapolation, and risk
Authors: Josef Lakonishok, Andrei Shleifer, and Robert W. Vishny
Published: Journal of Finance, 1994
DOI: 10.1111/j.1540-6261.1994.tb04772.x
While Fama and French (1992) argued that value stocks outperform because they're riskier, LSV proposed a radically different explanation: investors are systematically irrational about growth.
#What the Paper Found
Value vs. Glamour
LSV sorted stocks by price-to-earnings, price-to-book, price-to-cash flow, and sales growth. Then they measured 5-year returns:
| Category | Annual Return | Cumulative 5-Year |
|---|---|---|
| Deep Value (cheapest 10%) | 19.8% | 143% |
| Value (cheapest 30%) | 17.3% | 122% |
| Middle | 14.1% | 94% |
| Glamour (most expensive 30%) | 11.2% | 70% |
| Deep Glamour (most expensive 10%) | 9.3% | 56% |
| Value - Glamour Spread | 8.6% | 87% |
Value stocks outperform glamour stocks by roughly 8-11% per year, depending on the measure used. Over five years, the difference is staggering.
It's Not Risk
The critical finding: value stocks are not riskier. LSV tested multiple risk measures:
| Risk Measure | Value Stocks | Glamour Stocks |
|---|---|---|
| Beta | 1.01 | 1.08 |
| Standard deviation | Lower | Higher |
| Downside risk | Lower | Higher |
| Performance in recessions | Better | Worse |
Value stocks actually perform better during economic downturns. If value were riskier, the opposite should be true.
#The Extrapolation Bias
How It Works
- 1A company grows rapidly for several years (revenue doubles, earnings surge)
- 2Investors notice and extrapolate: "This growth will continue!"
- 3They bid up the price far beyond what fundamentals justify
- 4Growth inevitably slows (mean reverts to average)
- 5The stock underperforms as reality disappoints inflated expectations
Evidence of Mean Reversion
LSV showed that growth rates mean-revert dramatically:
| Growth Rate (Past 5 Years) | Growth Rate (Next 5 Years) |
|---|---|
| Top Quintile (fast growers) | Drops to near average |
| Bottom Quintile (slow/declining) | Improves to near average |
Past growth is a terrible predictor of future growth. Yet investors pay premium prices for past growth, creating the value premium.
#Glamour vs. Value: A Tale of Two Narratives
The Glamour Stock Story "This company is growing 25% per year. It's disrupting the industry. The market opportunity is massive. Sure, it trades at 50x earnings, but the growth justifies it."
The Value Stock Story "This company has struggled. Revenue is flat, margins are compressed. Nobody likes it. But it trades at 8x earnings, and the problems look temporary."
The Reality The glamour stock's 25% growth rate drops to 10% within three years. The stock, priced for 25% growth, falls.
The value stock stabilizes. 8x earnings with modest improvement generates strong returns as the multiple expands.
#The Debate: Risk vs. Behavior
This paper set up a fundamental debate in finance:
Fama & French: Value stocks outperform because they're genuinely distressed and risky. The premium is fair compensation for bearing that risk.
LSV: Value stocks outperform because investors make systematic errors. The premium is "free money" from exploiting behavioral biases.
Modern consensus: Both forces probably contribute. Some value stocks are genuinely risky (and some fail). But the systematic overpricing of glamour is also real.
#How This Applies to Our Rankings
LSV's findings support our inclusion of the value factor (15% weight) in the ranking model.
We use intangible-adjusted book-to-market ratios following Arnott et al. (2021), which improves on the basic measures LSV used. But the core insight is the same: investors systematically overpay for glamour and underpay for value.
Our multi-factor approach adds further protection. By combining value with profitability (30%), we avoid the "value trap"—cheap stocks that are cheap for good reason (they're unprofitable and deteriorating).
#Academic Source
Lakonishok, J., Shleifer, A., & Vishny, R. W. (1994). "Contrarian investment, extrapolation, and risk." Journal of Finance, 49(5), 1541-1578.
Last updated: February 1, 2026