Marx, “The Other Side of Value: The Gross Profitability Premium,” not only provided investors with new insights into the cross-section of stock returns but also led to the development of new factor models that incorporate a profitability factor.
Novy Marx's Findings
Before unpacking a more recent paper with new insights into how accruals and cash flows can impact profitability, I think it’s important to summarize some of Novy Marx's more fundamental findings on this premium:
• Profitability, as measured by gross profits-to-assets, has roughly the same power as the book-to-market ratio (a value measure) in predicting the cross-section of average returns.
• Surprisingly, profitable firms generate significantly higher returns than unprofitable firms, despite having significantly higher valuation ratios (for instance, higher price-to-book ratios).
• Profitable firms tend to be growth firms—they expand comparatively quickly. Gross profitability is a powerful predictor of future growth as well as earnings, free cash flow, and payouts.
• The most profitable firms earn average returns 0.31 percent per month higher than the least profitable firms. The data is statistically significant, with a t-statistic of This is a content preview space you can use to get your audience interested in what you have to say so they can’t wait to learn and read more. Pull out the most interesting detail that appears on the page and write it here.
