Investing in Growth Stocks: Bimodal Payoff Distribution and Expected 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, and stock returns, follow a bimodal U-shaped pattern. In contrast, the DRD of value stocks follows a traditional bell-shaped distribution. This divergence in payoff structures suggests growth stocks are more prone to structural shocks, such as disruptive technologies. Consequently, their pricing is heavily influenced by investors’ attitude toward exceptional outcomes, resulting in lower expected stock returns in equilibrium. We find that stocks with more pronounced bimodal payoffs are associated with significantly lower subsequent stock returns. This paper was accepted by Eric So, accounting. Supplemental Material: The data files are available at https://doi.org/10.1287/mnsc.2023.00980 .