The Value of Growth: Changes in Profitability and Future Stock Returns

61 Pages Posted: 10 Aug 2016 Last revised: 2 Feb 2017

Juan M. Sotes-Paladino

University of Melbourne - Department of Finance

George Jiaguo Wang

Manchester Business School; New York University - Stern School of Business

Chelsea Yaqiong Yao

Lancaster University - Management School; New York University (NYU) - Leonard N. Stern School of Business

Date Written: November 22, 2016

Abstract

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

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

Juan M. Sotes-Paladino

University of Melbourne - Department of Finance ( email )

Faculty of Economics and Commerce
Parkville, Victoria 3010 3010
Australia
+61 3 9035 9827 (Phone)
+61 3834 6914 (Fax)

George Jiaguo Wang

Manchester Business School

Crawford House
Oxford Road
Manchester, M15 6PB
United Kingdom
+447516389968 (Phone)

HOME PAGE: http://www.mbs.ac.uk/research/people/profiles/gwang

New York University - Stern School of Business ( email )

44 West 4th Street
New York, NY NY 10012
United States

Chelsea Yaqiong Yao (Contact Author)

Lancaster University - Management School ( email )

Department of Accounting and Finance
Lancaster University Management School
Lancaster, LA1 4YX
United Kingdom
+44 (0)1524 510731 (Phone)

New York University (NYU) - Leonard N. Stern School of Business ( email )

Stern School of Business
44 West 4th Street
New York, NY NY 10012
United States

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