IDEAS home Printed from https://ideas.repec.org/p/nbr/nberwo/15940.html
   My bibliography  Save this paper

The Other Side of Value: Good Growth and the Gross Profitability Premium

Author

Listed:
  • Robert Novy-Marx

Abstract

Profitability, as 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 average returns than unprofitable firms, despite having, on average, lower book-to-markets and higher market capitalizations. 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 cashflow durations, and have lower levels of operating leverage, than unprofitable firms. Controlling for gross profitability explains most earnings related anomalies, as well as a wide range of seemingly unrelated profitable trading strategies.

Suggested Citation

  • Robert Novy-Marx, 2010. "The Other Side of Value: Good Growth and the Gross Profitability Premium," NBER Working Papers 15940, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:15940
    Note: AP
    as

    Download full text from publisher

    File URL: http://www.nber.org/papers/w15940.pdf
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Berk, Jonathan B, 1995. "A Critique of Size-Related Anomalies," The Review of Financial Studies, Society for Financial Studies, vol. 8(2), pages 275-286.
    2. 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 607-636, May-June.
    3. Lakonishok, Josef & Shleifer, Andrei & Vishny, Robert W, 1994. "Contrarian Investment, Extrapolation, and Risk," Journal of Finance, American Finance Association, vol. 49(5), pages 1541-1578, December.
    4. Chan, Louis K C & Jegadeesh, Narasimhan & Lakonishok, Josef, 1996. "Momentum Strategies," Journal of Finance, American Finance Association, vol. 51(5), pages 1681-1713, December.
    5. Fama, Eugene F & French, Kenneth R, 1992. "The Cross-Section of Expected Stock Returns," Journal of Finance, American Finance Association, vol. 47(2), pages 427-465, June.
    6. Fama, Eugene F. & French, Kenneth R., 1997. "Industry costs of equity," Journal of Financial Economics, Elsevier, vol. 43(2), pages 153-193, February.
    7. Ohlson, Ja, 1980. "Financial Ratios And The Probabilistic Prediction Of Bankruptcy," Journal of Accounting Research, Wiley Blackwell, vol. 18(1), pages 109-131.
    8. Lu Zhang, 2005. "The Value Premium," Journal of Finance, American Finance Association, vol. 60(1), pages 67-103, February.
    9. 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.
    10. Fama, Eugene F. & French, Kenneth R., 2006. "Profitability, investment and average returns," Journal of Financial Economics, Elsevier, vol. 82(3), pages 491-518, December.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Beneish, M.D. & Lee, C.M.C. & Nichols, D.C., 2015. "In short supply: Short-sellers and stock returns," Journal of Accounting and Economics, Elsevier, vol. 60(2), pages 33-57.
    2. Stambaugh, Robert F. & Yu, Jianfeng & Yuan, Yu, 2012. "The short of it: Investor sentiment and anomalies," Journal of Financial Economics, Elsevier, vol. 104(2), pages 288-302.
    3. Lee, Eunju & Piqueira, Natalia, 2017. "Short selling around the 52-week and historical highs," Journal of Financial Markets, Elsevier, vol. 33(C), pages 75-101.
    4. Stambaugh, Robert F. & Yu, Jianfeng & Yuan, Yu, 2014. "The long of it: Odds that investor sentiment spuriously predicts anomaly returns," Journal of Financial Economics, Elsevier, vol. 114(3), pages 613-619.
    5. Hwang, Soosung & Cho, Youngha & Noh, Sanha, 2022. "The cost of overconfidence in public information," International Review of Financial Analysis, Elsevier, vol. 79(C).
    6. Olivier Ledoit & Michael Wolf & Zhao Zhao, 2016. "Efficient Sorting: A More Powerful Test for Cross-Sectional Anomalies," ECON - Working Papers 238, Department of Economics - University of Zurich, revised May 2018.
    7. Christian Walkshäusl & Sebastian Lobe, 2014. "The Alternative Three†Factor Model: An Alternative beyond US Markets?," European Financial Management, European Financial Management Association, vol. 20(1), pages 33-70, January.
    8. Qi Liu & Lei Lu & Bo Sun & Hongjun Yan, 2015. "A Model of Anomaly Discovery," International Finance Discussion Papers 1128, Board of Governors of the Federal Reserve System (U.S.).
    9. Feng Yu & Guizhou Wang, 2023. "Assessing the Impact of Business Model Innovation on Firm Performance: Insights from the China Growth Enterprise Market," International Business Research, Canadian Center of Science and Education, vol. 16(4), pages 1-51, April.
    10. Adam Zaremba, 2017. "Combining Equity Country Selection Strategies," Contemporary Economics, University of Economics and Human Sciences in Warsaw., vol. 11(1), March.
    11. Chung, San-Lin & Hung, Chi-Hsiou & Yeh, Chung-Ying, 2012. "When does investor sentiment predict stock returns?," Journal of Empirical Finance, Elsevier, vol. 19(2), pages 217-240.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Kewei Hou & Chen Xue & Lu Zhang, 2017. "Replicating Anomalies," NBER Working Papers 23394, National Bureau of Economic Research, Inc.
    2. Novy-Marx, Robert, 2013. "The other side of value: The gross profitability premium," Journal of Financial Economics, Elsevier, vol. 108(1), pages 1-28.
    3. Eero Pätäri & Timo Leivo, 2017. "A Closer Look At Value Premium: Literature Review And Synthesis," Journal of Economic Surveys, Wiley Blackwell, vol. 31(1), pages 79-168, February.
    4. Lu Zhang, 2017. "The Investment CAPM," European Financial Management, European Financial Management Association, vol. 23(4), pages 545-603, September.
    5. Kewei Hou & Haitao Mo & Chen Xue & Lu Zhang, 2019. "Which Factors?," Review of Finance, European Finance Association, vol. 23(1), pages 1-35.
    6. de Groot, Wilma & Huij, Joop, 2018. "Are the Fama-French factors really compensation for distress risk?," Journal of International Money and Finance, Elsevier, vol. 86(C), pages 50-69.
    7. Wu, Jin (Ginger) & Zhang, Lu, 2010. "Does Risk Explain Anomalies? Evidence from Expected Return Estimates," Working Paper Series 2010-18, Ohio State University, Charles A. Dice Center for Research in Financial Economics.
    8. Da, Zhi & Guo, Re-Jin & Jagannathan, Ravi, 2012. "CAPM for estimating the cost of equity capital: Interpreting the empirical evidence," Journal of Financial Economics, Elsevier, vol. 103(1), pages 204-220.
    9. Richardson, Scott & Tuna, Irem & Wysocki, Peter, 2010. "Accounting anomalies and fundamental analysis: A review of recent research advances," Journal of Accounting and Economics, Elsevier, vol. 50(2-3), pages 410-454, December.
    10. Stefan Nagel, 2013. "Empirical Cross-Sectional Asset Pricing," Annual Review of Financial Economics, Annual Reviews, vol. 5(1), pages 167-199, November.
    11. Andreou, Christoforos K. & Lambertides, Neophytos & Panayides, Photis M., 2021. "Distress risk anomaly and misvaluation," The British Accounting Review, Elsevier, vol. 53(5).
    12. Calvet, Laurent E. & Betermier, Sebastien & Jo, Evan, 2019. "A Supply and Demand Approach to Equity Pricing," CEPR Discussion Papers 13974, C.E.P.R. Discussion Papers.
    13. Lipson, Marc L. & Mortal, Sandra & Schill, Michael J., 2011. "On the Scope and Drivers of the Asset Growth Effect," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 46(6), pages 1651-1682, December.
    14. David Hirshleifer, 2001. "Investor Psychology and Asset Pricing," Journal of Finance, American Finance Association, vol. 56(4), pages 1533-1597, August.
    15. Papanastasopoulos, Georgios & Thomakos, Dimitrios & Wang, Tao, 2011. "Information in balance sheets for future stock returns: Evidence from net operating assets," International Review of Financial Analysis, Elsevier, vol. 20(5), pages 269-282.
    16. Francesco Franzoni & José M. Marín, 2006. "Pension Plan Funding and Stock Market Efficiency," Journal of Finance, American Finance Association, vol. 61(2), pages 921-956, April.
    17. Ang, Tze Chuan ‘Chewie’ & Lam, F.Y. Eric C. & Wei, K.C. John, 2020. "Mispricing firm-level productivity," Journal of Empirical Finance, Elsevier, vol. 58(C), pages 139-163.
    18. Guo, Hui & Savickas, Robert, 2010. "Relation between time-series and cross-sectional effects of idiosyncratic variance on stock returns," Journal of Banking & Finance, Elsevier, vol. 34(7), pages 1637-1649, July.
    19. Clifford S. Asness & Andrea Frazzini & Lasse Heje Pedersen, 2019. "Quality minus junk," Review of Accounting Studies, Springer, vol. 24(1), pages 34-112, March.
    20. Wu, Yuliang & Mazouz, Khelifa, 2016. "Long-term industry reversals," Journal of Banking & Finance, Elsevier, vol. 68(C), pages 236-250.

    More about this item

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:nbr:nberwo:15940. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: the person in charge (email available below). General contact details of provider: https://edirc.repec.org/data/nberrus.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.