Explanation for the Three Factors
Factor 1. The Size Factor (Small Cap)
A small-cap company generally has a market capitalization between $300 million and $2 billion. Small-cap stocks tend to outperform those with a larger market cap. That phenomenon is known as the “small-cap premium.”. Small-cap stocks tend to have lower stock prices, and these lower prices mean that price appreciation tends to be larger than that of large-cap stocks.
Factor 2. The Value Factor
Value investing is the art of buying stocks that trade at a significant discount to their intrinsic value. Value investors achieve this by looking for companies on cheap valuation metrics, typically low multiples of their profits or assets, for reasons not justified over the longer term.
Factor 3. Profitability Factor
More profitable firms deliver stronger returns despite higher valuation ratios. Operating profits before depreciation and amortization, less interest expense. We then scale profits by book value to adjust for differences in company size, which is why this is called relative profitability.
