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The other side of value: The gross profitability premium

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  • Novy-Marx, Robert

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.

Suggested Citation

  • Novy-Marx, Robert, 2013. "The other side of value: The gross profitability premium," Journal of Financial Economics, Elsevier, vol. 108(1), pages 1-28.
    • Handle: RePEc:eee:jfinec:v:108:y:2013:i:1:p:1-28
    DOI: 10.1016/j.jfineco.2013.01.003
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    References listed on IDEAS

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    More about this item

    Keywords

    Profitability; Value premium; Factor models; Asset pricing; Quality investing;
    All these keywords.

    JEL classification:

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

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