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Historically, the finance community (both academics and investment firms) has divided stocks into two categories: cheap and expensive. Initially, the book-to-price ratio was used to allocate stocks into growth (expensive) or value (cheap) indices. Other metrics, such as price-to-earnings, price-to-sales, and price-to-cash flow, are now also commonly used. What was not value was growth and vice versa, with some crossover stocks allocated partly to growth and partly to value as is the case with the Russell classifications.

Robert Arnott, Chris Brightman, Campbell Harvey, Que Nguyen, and Omid Shakernia, authors of the July 2025 study “Fundamental Growth,” took a different approach:

“Expensive does not equate to growth. When investing in growth, perhaps we should focus on the fundamental information that indicates that a company is growing or poised to grow because of innovations, not whether the valuation multiples are high.”

With that in mind, they analyzed conventional growth indices and their construction methodologies, scrutinizing how growth stocks are selected and weighted in traditional indices. They focused on two critical areas: the criteria used to identify growth stocks, and the weighting methodologies employed once stocks are selected. Importantly, while many growth indices incorporate short-horizon analyst forecasts, such as two-year forward earnings estimates, to assess future growth potential, they relied exclusively on historically observed fundamental measures—such as growth in sales, profitability, and R&D spending—that reflect actual, realized business performance. “This emphasis on verifiable data avoids the noise embedded in speculative projections and offers a potentially more reliable foundation for portfolio construction.”

Notably, they expunged price from both the selection and the weighting criteria:

“Our approach moves beyond price-based measures, grounding growth investing in observable economic fundamentals independent of market price.” They then constructed a growth portfolio based solely on fundamental information, ensuring that the weighting of stocks in the portfolio was not impacted by current prices.

For each fundamental measure, they considered two measures of growth: the magnitude of growth (the dollar value of change in the fundamental over the trailing five years) and the rate of growth (the per-share change—to account for dilution—in the fundamental over the trailing five years, normalized by sales per share as of t-5). They used the rate of growth to select securities for the growth portfolio and the dollar magnitude of growth to weight securities in the portfolio. Unfortunately, they did not state what they did with firms with starting values that were zero or negative.
 

Notes: Details of the computation of both the magnitude and rate of growth for each fundamental measure over a five-year horizon, where we use the notation for the difference operator Δℎ𝑋𝑋𝑡𝑡 ∶= 𝑋𝑋𝑡𝑡 − 𝑋𝑋𝑡𝑡−ℎ. The magnitude of growth is calculated as the raw dollar change, and the rate of growth is normalized by sales to allow for meaningful comparisons across firms of different sizes. Furthermore, in computing the magnitude of growth, all fundamentals are computed on a per-share basis to account for possible dilution. Shaded rows correspond to fundamentals associated with balance sheet or payout growth, types of growth that are generally less aligned with a growth investing style.
 

Their data sample covered the period March 1969 through December 2024, and the top 98% of US stocks (excluding microcaps). From this universe, they selected the top 1,000 companies based on their rate of growth: the five-year per-share change in a fundamental metric (e.g., sales per share), normalized by the initial sales per share. Within this selection, they assigned portfolio weights using the absolute magnitude of growth over the same period (e.g., total dollar growth in sales), setting weights to zero for firms with negative growth, if any. Portfolios were rebalanced annually each March. The following is a summary of their key findings.

Key Findings

“Anti-Value” Stocks Are Not True Growth Stocks: The authors argued that conventional growth indices make a fundamental error by conflating expensive stocks with growth stocks—simply because a stock trades at a high valuation does not mean it represents genuine growth. Many “anti-value” stocks (those trading at very expensive multiples) lack the underlying business fundamentals that drive sustainable growth—leading to suboptimal portfolio construction and disappointing returns.

Fundamental Growth Measures Are Superior: Portfolios composed of fast-growing firms significantly outperformed the market over the full period, irrespective of valuation. In contrast, slow growth and expensive firms (the segment most vulnerable to misclassification as growth) underperformed by a wide margin. Thus, growth stock selection should be based on actual business fundamentals rather than market pricing. Metrics such as growth in sales, profits, and research and development spending provide more reliable indicators of true growth potential than price-based measures. When growth indices were weighted by objective measures of growth (even at higher valuations) rather than market capitalization, performance markedly improved. This was true for the growth metrics of R&D, Sales, Gross Profit, Net Income, and Cash Flow (see table below).  
 

Notes: These tables compare the performance of the fundamental growth portfolios to traditional benchmarks across both unadjusted and risk-adjusted dimensions over the period from March 1969 to December 2024. Each fundamental growth portfolio is formed by selecting the top 1,000 companies based on the rate of growth in the fundamentals and weighting them by the corresponding magnitude of growth. Panel A presents raw performance measures, including annualized return, volatility, Sharpe ratio, annualized CAPM alpha with corresponding t-statistic, and portfolio turnover. Panel B uses the Fama-French-Carhart four-factor model (including market beta, size, value, and momentum). The benchmarks are the CW 1000 portfolio, which selects and weights the top 1,000 firms by market capitalization, and the CW Growth portfolio, which is a traditional cap-weighted growth-style portfolio. Shaded rows reflect portfolios built from retention and distribution growth measures that are less consistent with a growth investing style. Source: Research Affiliates, based on data from CRSP/Compustat.

The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged and do not reflect management or trading fees, and one cannot invest directly in an index
 

They then constructed a composite fundamental growth signal that blends measures capturing business growth in sales and profits as well as innovation.
 

The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged and do not reflect management or trading fees, and one cannot invest directly in an index
 

Bottom line: When growth indices were weighted by objective measures of growth rather than market capitalization, performance markedly improved.
 

The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged and do not reflect management or trading fees, and one cannot invest directly in an index
 

The Impact of Concentration

Fundamental growth-weighted portfolios outperformed market cap-weighted growth indices across all concentration levels, displaying higher returns, Sharpe ratios, and information ratios—with only moderate increases in turnover. For example, the average portfolio return increased monotonically from 12.4% for the Fundamental Growth (FG) 1000 to 15.3% the FG100. The volatility and tracking error also increased, and the information ratio eroded modestly with more concentration. Concentration had little impact on the Sharpe ratios. However, the four-factor alphas increased monotonically from 1.7% for the FG 1000 to 6.4% for the FG 100.

Some Stocks Don’t Belong in Either Camp: The authors concluded that “stocks with poor growth prospects and unattractive valuations may have no place in either value or growth indices”, challenging the conventional binary classification system and suggesting a more nuanced approach to equity categorization. While the statement is logical, their methodology only examined past growth, not future growth prospects.

Regime Sensitivity

The outperformance of fundamental growth strategies was concentrated in periods of elevated market and economic stress or systemic risk. Across multiple measures of stress (idiosyncratic volatility, the VIX, financial stress, and economic policy uncertainty) excess returns were significantly higher during high-friction periods compared with low-friction ones. The authors hypothesized:

“Periods of heightened risk amplify market inefficiencies, especially for growth-oriented stocks with long-duration cash flows. In such environments, investors may become more short-term oriented or constrained by risk limits, leading to greater mispricing of firms with strong underlying fundamentals…. Alternatively, these results are consistent with limits-to-arbitrage theories. When volatility and systemic risk are high, arbitrage capital becomes more constrained, and mispricings are more likely to persist. Fundamental growth strategies appear to benefit from this dynamic, outperforming precisely when traditional arbitrage mechanisms are impaired.”

Robustness Tests

In a test of robustness, the results were similar of UK, Europe ex-UK, and Japanese stocks.
 

Notes: This table presents annualized performance statistics from March 1991 to December 2024 for international portfolios in the UK, Europe ex-UK, and Japan. Each row compares the Fundamental Growth 85% portfolio with two benchmarks: CW 85%, which selects and weights the top 85% of firms by cumulative market capitalization, and CW Growth, which follows the traditional growth methodology that includes price-based growth indicators within that same universe. Source: Research Affiliates; data from Worldscope/Datastream.

The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged and do not reflect management or trading fees, and one cannot invest directly in an index

The author’s findings led them to offer two simple insights.

“First, why not exclude expensive low-growth stocks from both portfolios? Second, why not weight stocks in a growth portfolio in proportion to the magnitude of growth that they have delivered rather than in proportion to the price or market cap of the stock?”

Other Research Findings

Since the returns shareholder’s ultimately earn are based on future profits, it raises the question of why five-year growth in sales should be included as a measure of growth—shareholders don’t eat sales, they eat profitability. The authors of the 2009 study “Growing Profitable or Growing From Profits” found that sales growth is often not a sign of sound development— firms which grow without first securing high levels of profitability tend to be less successful in subsequent periods compared to firms that first secure high profitability at low growth. They concluded that investors would benefit “by adopting a more nuanced view of firm growth that explicitly incorporates its intricate relationship with profitability.” The Fundamental Growth Index does consider growth in profitability, though it is past, not forward looking profitability scaled by assets or book value.

The authors of the 2023 study “Firm Growth and Profitability” found that their results supported prior findings on initial profitability being more important than initial growth for achieving high performance in both performance dimensions—companies that achieve sustainable, profitable growth tend to outperform those focused solely on top-line growth without regard to profitability metrics.

The authors of the 2024 study “R&D, Innovation, and the Stock Market” investigated the relation between inventive input (R&D), inventive output (the economic value of patents, EVP), firm-level profitability and asset growth, and stock returns and found that current R&D and EVP do forecast future profitability (though neither forecasts asset growth)—while current R&D forecasts future profitability, when it comes to R&D five years might be an eternity. 

Another observation regarding the “Fundamental Growth Index” is while the author’s did present data for 10 different measures of fundamental growth (see table 3), their fundamental index included just three of the metrics, raising the question of after-the-fact cherry picking of metrics to get the best results. What was the hypothesis for choosing those three?   

Investor Takeaways

The research does offer several practical takeaways that could change how investors approach growth investing:

Portfolio Construction Implications: Growth investors should focus on strategies that use fundamental growth measures rather than price-based criteria—selecting stocks based on actual business growth metrics like profit growth and innovation investment rather than simply high price-to-earnings or price-to-book ratios.

Risk Management Considerations: Be wary of growth strategies that systematically favor expensive stocks, as these approaches may be taking unnecessary valuation risk without corresponding growth benefits—a fundamental approach to growth investing may offer better risk-adjusted returns.

Index Selection Strategies: The research suggests that traditional market-cap weighted growth indices may be suboptimal. Investors should consider fundamentally weighted growth indices or strategies that weight companies based on their actual growth characteristics rather than their market values.

Beyond the Growth/Value Dichotomy The research challenges investors to think beyond the traditional growth versus value framework. Some stocks may deserve neither classification, suggesting that quality-focused or more nuanced factor-based approaches might be superior to the binary growth/value distinction.

Summary

The authors’ analysis challenged the widespread practice of using price-based measures to define growth investing and explored alternative approaches based on fundamental business metrics. The “Fundamental Growth” research provides compelling evidence that conventional growth investing is fundamentally flawed. By focusing on actual business fundamentals rather than market pricing, and by using objective fundamental growth measures (as well quality measures) for portfolio weighting, investors can potentially achieve significantly better returns.

The key insight is elegantly simple: growth investing should be about identifying and investing in companies that have actually grown their businesses, not just companies that happen to trade at high valuations.

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