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Asset Growth a Bad Sign for Stocks Everywhere?

Posted in Fundamental Valuation

Does the asset growth effect (growth is bad) exist in non-U.S. equity markets? In their July 2012 paper entitled “The Asset Growth Effect: Insights from International Equity Markets”, Akiko Watanabe, Yan Xu, Tong Yao and Tong Yu investigate the asset growth effect in and across international stock markets. They consider two tests, both based on annual data available as of the end of June each year: (1) form portfolios of stocks ranked in deciles (tenths) by asset growth rate within countries and pooled across countries, and calculate next-year average gross portfolio returns; and, (2) within each country, regress next-year gross stock return versus asset growth rate. Using return and asset data for non-financial stocks in 43 country markets (including the U.S.) that have at least 30 qualifying stocks during July 1982 through June 2010, they find that:

  • In general, the asset growth effect exists outside the U.S., with relatively high asset growth rates indicating relatively low future stock returns.
    • For the 42 non-U.S. countries evaluated separately, the decile of stocks with the lowest asset growth rates outperforms the decile with the highest rates over the next year by a gross average 3.5% (3.8%) based on equal (market valuation) weighting. Return spreads are positive (negative) for 29 (13) countries in local currencies and 30 (12) in U.S. dollars.
    • For stocks pooled across the 42 non-U.S. countries, the decile with the lowest asset growth rates outperforms the decile with the highest over the next year by a gross average 6.4% (4.0%) based on equal (market valuation) weighting.
    • For regressions by country, asset growth rate relates negatively to future stock return for 30 of 42 non-U.S. countries in both local currencies and U.S. dollars.
  • The power of asset growth rate to predict future stock return remains significant after controlling for size, book-to-market, momentum and operating profitability.
  • The asset growth effect tends to be stronger in markets that are more informationally efficient. In other words, costs of trading do not explain the effect.

In summary, evidence suggests that relatively strong asset growth indicates relatively weak stock performance in most equity markets outside the U.S.

Cautions regarding findings include:

  • The study uses gross, not net portfolio returns. Incorporating reasonable trading frictions for periodic (here, annual) portfolio reformation would reduce these returns. 
  • As stated, over a third of the equity markets analyzed do not exhibit the negative relationship between asset growth rate and future stock return found in the U.S.

See “Asset Growth Rate as a Return Indicator” and “Asset Growth and the Cross-Section of Stock Returns” for comparable studies focused on U.S. stocks.

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