Working Paper: NBER ID: w15940
Authors: 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.
Keywords: profitability; gross profit; value strategies; average returns
JEL Codes: G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| gross profitability (L21) | average returns (G12) |
| controlling for gross profitability (L21) | performance of value strategies (D46) |
| higher gross profits-to-assets (G32) | higher average returns (G11) |
| lower book-to-market ratios (G32) | lower average returns (G19) |