Where Is the Value Premium?

The value premium is driven by 7 percent of the stock market. The 93 percent of market capitalization held most by institutional investors is value premium free. In contrast, in stocks held most by individual investors, the value premium, even when the stocks are value weighted, reaches a staggering 185 bps per month. In addition, the value premium is a long-side anomaly. It is a value premium puzzle, not a growth discount puzzle.The premise of this article is that if the value premium is a result of both pricing errors and limited arbitrage, then the value premium should be concentrated in stocks that are both held by relatively less sophisticated investors and expensive to arbitrage. Such a concentration is suggested in the literature but has not been quantified. In this article, I show that, indeed, at least 93 percent of market capitalization is free of a value premium.Using institutional ownership (IO) as a parsimonious way to classify stocks by their mispricing likelihood, I show that the value premium monotonically decreases from a high 185 bps for low-IO stocks to a negligible 13 bps for high-IO stocks. This result also holds when returns are value weighted and, importantly, is driven mainly by the long side. Low-IO value stocks are those with the most abnormal returns. The anomaly is a value premium, not a growth discount, as is sometimes argued. Another way to express this important point is that over the last 20 years (on an equally weighted basis), only 15 percent of the value premium came from the short side. Even if one could not short growth stocks, one could short the S&P 500 Index and be long on value stocks, which would have generated 85 percent of the unconstrained value premium.The extreme concentration of the value premium has important practical implications. First, arbitrageurs can expect to face substantial costs when trying to arbitrage the value premium, and those focusing on the stocks most held by institutional investors (the larger, more liquid stocks) will have difficulties generating arbitrage profits. The value premium concentrates where arbitrageurs usually do not go. This reason is also why studies have found that value and growth mutual funds perform the same. Second, studies that select a subsample of stocks that, for instance, either have at least two to five analysts following the stocks or are traded on the NYSE end up with a sample that is almost free of the value anomaly. Such a fact is important to bear in mind when interpreting the results found in such samples.