61 Pages Posted: 10 Aug 2016 Last revised: 2 Feb 2017
Date Written: November 22, 2016
The change in a firm’s profitability, or profitability growth, has incremental power to predict stock returns over current profitability and other well-known cross-sectional determinants. From 1975 to 2014, the Fama and French five-factor alpha on a long-short strategy based on profitability growth is 1.14% per month. This strategy remains highly profitable after controlling for size, book-to-market ratio, profitability, or momentum. The effect is stronger among firms experiencing steady, as opposed to dramatic, changes in profitability growth. Although price momentum cannot explain the profitability-growth effect, an augmented Fama and French three-factor model that includes a profitability-growth factor captures the momentum anomaly.
Keywords: Profitability; Growth; Return Predictability; Stock Returns
JEL Classification: G11; G12
Suggested Citation: Suggested Citation
Sotes-Paladino, Juan M. and Wang, George Jiaguo and Yao, Chelsea Yaqiong, The Value of Growth: Changes in Profitability and Future Stock Returns (November 22, 2016). 29th Australasian Finance and Banking Conference 2016. Available at SSRN: https://ssrn.com/abstract=2819183