Investing in Growth Stocks : Bimodal Payoff Distribution and Expected Stock Returns

This paper documents that the payoffs from investing in growth stocks, as measured by the decile-rank distributions (DRD) of future revenues, earnings, investment, as well as stock returns, follow a bimodal U-shaped distribution. By contrast, the DRD of value stocks follow a traditional bell-shaped curve. This difference in distributions suggests growth stocks are more likely to be subject to structural shocks, such as disruptive technologies. The pricing of growth stocks is thus more affected by investors’ attitude toward extreme outcomes, leading to low expected stock returns in equilibrium (Kahneman and Tversky 1979; Barberis and Huang 2008). We show that stocks with more significant bimodal payoffs command significantly lower subsequent stock returns