Investor Overreaction in International Stock Markets

W. Scott Bauman
C. Mitchell Conover, University of Richmond
Robert E. Miller


A study was conducted to determine why value stocks generally outperform growth stocks in international stock markets. Data from the 20 established markets represented by the Morgan Stanley Capital International Europe/Australasia/Far East Index and the Canadian market were analyzed for the period 1986-96. Value stocks and growth stocks were classified on the basis of two separate measures—price-to-book value ratio and past-three-year earnings per share (EPS) growth rates—and in order to facilitate cross country market comparisons, rates of returns, EPS growth rates, and corporate stock market capitalizations were determined in U.S. dollar terms. Findings reveal that investors overreact by propelling the prices of growth stocks too high and the prices of value stocks too low. This is accounted for by the fact that investors and research analysts tend to suppose that past growth rates in EPS will continue in the future, although evidence demonstrates that extreme past growth rates tend to return to a normal mean. As a result, when earnings disappointments are disclosed, stocks previously thought to be growth stocks tend to produce lower returns than value stocks.