The Other Side of Value: Good Growth and the Gross Profitability Premium
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.
Financial support from the Center for the Research in Securities Prices at the University of Chicago Booth School of Business is gratefully acknowledged. The views expressed herein are those of the author and do not necessarily reflect the views of the National Bureau of Economic Research.
Novy - Marx, Robert, “The Other Side of Value: The Gross Profitability Premium , ” Journal of Financial Economics, 108(1) , 1 - 28, 2013.