Abstract:
PURPOSE : To investigate whether investors value the future growth from acquisitions
and the subsequent realisations thereof accurately.
DESIGN / METHPDOLOGY / APPROACH : The paper calculates conventional and adjusted
market-to-book ratios and investigates abnormal cumulative returns over 20 quarters
after portfolio formation for a sample of S&P 500 firms using a hedge portfolio and
regression approach.
FINDINGS : Hedge portfolios formed using adjusted market-to-book ratios underperform
conventional hedge portfolios over a five year period. Dividing the hedge into its
comprising elements reveals that the underperformance of the adjusted hedge is mainly
caused by weaker returns from value firms.
RESAERCH LIMITATIONS / IMPLICATIONS : Findings are specific to large firms in a specific
setting and future research is needed to determine if findings are equally applicable to
other situations. Findings imply that investors underrate the growth from new
acquisitions and overrate the extent to which this has materialised. PRACTICAL IMPLICATIONS : The study highlights that the extrapolation of future growth
rates should be carefully considered in any equity valuation of a firm with current or
past acquisitions.
ORIGINALITY / VALUE : This study shows that inaccurate valuation of the growth of new
acquisitions and the realisation thereof is at least partially responsible for the value
versus growth phenomenon. It shows that the accounting information could be
improved and highlights the importance of extrapolating past growth rates with care .
