The Other Side of Value: The Gross Profitability Premium

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Smith1776
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The Other Side of Value: The Gross Profitability Premium

Post by Smith1776 » Tue Dec 01, 2020 1:39 pm

The quality factor is one of the most well known and well-established anomalies in finance. This is a copy of Robert Novy-Marx's landmark 2012 paper on the quality factor and its robustness.

Despite quality's visibility as a factor it is not widely known that it is really the "other side" of the value factor. The value factor is, in effect, buying assets at cheap prices. Investing in the quality factor is a way of buying productive assets and avoiding unproductive assets.

Novy-Marx demonstrates that quality has nearly the same explanatory power to explain returns as value, and that both strategies are enhanced when combined.

http://rnm.simon.rochester.edu/research/OSoV.pdf
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.
I still find the James Rickards portfolio fascinating.
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Smith1776
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Re: The Other Side of Value: The Gross Profitability Premium

Post by Smith1776 » Tue Dec 01, 2020 3:38 pm

Follow up paper where Novy-Marx demonstrates that Benjamin Graham had it right with his ideas on investing all along.

https://citeseerx.ist.psu.edu/viewdoc/d ... 1&type=pdf
I still find the James Rickards portfolio fascinating.
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