Persistence in Growth Versus Market Expectations

We measure the persistence and predictability of sales and earnings growth for Australian-listed firms from 1989 to 2006. In contrast to results from the United States, there is evidence of persistence in growth. There is close to a two-thirds chance that a firm reporting growth above the industry median in one year repeats this performance in the following year. However, there is little evidence that valuation ratios—measured as revenue, earnings or book value of equity relative to market capitalisation—are particularly useful in predicting future growth. Instead, they reflect recent historical growth, especially in the case of the book-to-market ratio. Firms with low book-to-market ratios have relatively high growth over the previous five years, but their growth over the subsequent five years is almost indistinguishable from firms with high book-to-market ratios. The results are consistent with the hypothesis that value stocks outperform growth stocks because investors overstate firms' ability to consistently make high-growth investments.