S&P/Barra Indexes -- Description
Part 1 - Overview | Part 2 | Part 3

In 1992, Standard and Poor's and Barra began a collaboration to produce Growth and Value subsets of S&P's industry-leading equity indexes. Academic research pioneered by Nobel Laureate William Sharpe, and continued by Eugene Fama, Kenneth French and others, have confirmed the validity of the growth/value distinction in terms of differential returns over time. The sole criteria for the S&P/Barra Growth/Value split is the book value of a common equity divided by the market capitalization of a firm.

The S&P/Barra Growth and Value indexes are constructed by dividing the stocks in an index according to a single attribute: book-to-price ratio. This splits the index into two mutually exclusive groups designed to track two of the predominant investment styles in the U.S. equity market. The value index contains firms with higher book-to-price ratios; conversely, the growth index has firms with lower book-to-price ratios. Each company in the index is assigned to either the value or growth index so that the two style indexes "add up" to the full index. Like the full S&P indexes, the value and growth indexes are capitalization-weighted, meaning that each stock is weighted in proportion to its market value.

The design of the indexes is an outgrowth of research into investment styles in the U.S. equity market performed by 1990 Nobel Laureate William F. Sharpe. Sharpe found that the value/growth dimension (as represented by price-to-book ratios), along with the large/small dimension, (as represented by market capitalization) appears to explain many of the differences in returns to U.S. equity mutual funds. The importance of the distinction between value and growth stocks was also explored by Eugene Fama and Kenneth French. Fama and French found that the combination of book-to-price ratios and market capitalization explain much of the cross-sectional variability in average stock returns over the period from 1963 to 1990. Furthermore, they found that book-to-price ratios play an even more important role than market capitalization in capturing this return variability.

Clearly, there is no definitive way to characterize a "value" versus a "growth" stock. However, the book-to-price ratio has the advantage of being simple and easy to understand, is mutually exclusive, and captures one of the fundamental differences between companies generally classified as value companies or growth companies. Additionally, book-to-price ratios tend to be more stable over time than alternative measures such as price-to-earnings ratios, historical earnings growth rates, or return on equity. This results in indexes with relatively low turnover.

Part 2 - Index Composition