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The other side of value: The gross profitability premium

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  • Novy-Marx, Robert
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    Abstract

    Profitability, measured by gross profits-to-assets, has roughly the same power as book-to-market predicting the cross section of average returns. Profitable firms generate significantly higher returns than unprofitable firms, despite having significantly higher valuation ratios. Controlling for profitability also dramatically increases the performance of value strategies, especially among the largest, most liquid stocks. These results are difficult to reconcile with popular explanations of the value premium, as profitable firms are less prone to distress, have longer cash flow durations, and have lower levels of operating leverage. Controlling for gross profitability explains most earnings related anomalies and a wide range of seemingly unrelated profitable trading strategies.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Financial Economics.

    Volume (Year): 108 (2013)
    Issue (Month): 1 ()
    Pages: 1-28

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    Handle: RePEc:eee:jfinec:v:108:y:2013:i:1:p:1-28

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    Web page: http://www.elsevier.com/locate/inca/505576

    Related research

    Keywords: Profitability; Value premium; Factor models; Asset pricing; Quality investing;

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    References

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    1. Lakonishok, Josef & Shleifer, Andrei & Vishny, Robert W, 1994. " Contrarian Investment, Extrapolation, and Risk," Journal of Finance, American Finance Association, vol. 49(5), pages 1541-78, December.
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    6. Martin Lettau & Jessica A. Wachter, 2007. "Why Is Long-Horizon Equity Less Risky? A Duration-Based Explanation of the Value Premium," Journal of Finance, American Finance Association, vol. 62(1), pages 55-92, 02.
    7. Fama, Eugene F. & French, Kenneth R., 1993. "Common risk factors in the returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 33(1), pages 3-56, February.
    8. Konan Chan & Louis K. C. Chan & Narasimhan Jegadeesh & Josef Lakonishok, 2006. "Earnings Quality and Stock Returns," The Journal of Business, University of Chicago Press, vol. 79(3), pages 1041-1082, May.
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    10. Ball, Ray, 1978. "Anomalies in relationships between securities' yields and yield-surrogates," Journal of Financial Economics, Elsevier, vol. 6(2-3), pages 103-126.
    11. Fama, Eugene F & MacBeth, James D, 1973. "Risk, Return, and Equilibrium: Empirical Tests," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 607-36, May-June.
    12. Robert Novy-Marx, 2011. "Operating Leverage," Review of Finance, European Finance Association, vol. 15(1), pages 103-134.
    13. Berk, Jonathan B, 1995. "A Critique of Size-Related Anomalies," Review of Financial Studies, Society for Financial Studies, vol. 8(2), pages 275-86.
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    Cited by:
    1. Itamar Drechsler & Qingyi Freda Drechsler, 2014. "The Shorting Premium and Asset Pricing Anomalies," NBER Working Papers 20282, National Bureau of Economic Research, Inc.
    2. Aharoni, Gil & Grundy, Bruce & Zeng, Qi, 2013. "Stock returns and the Miller Modigliani valuation formula: Revisiting the Fama French analysis," Journal of Financial Economics, Elsevier, vol. 110(2), pages 347-357.

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