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

73 Pages Posted: 10 Aug 2016 Last revised: 2 Jun 2019

See all articles by Juan M. Sotes-Paladino

Juan M. Sotes-Paladino

Universidad de los Andes, Chile; University of Melbourne - Department of Finance

George Jiaguo Wang

Lancaster University Management School; New York University - Stern School of Business

Yaqiong (Chelsea) Yao

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

Date Written: May 2, 2019

Abstract

The change in a firm’s profitability, or profitability growth (PG), has incremental power to predict stock returns over profitability level and other well-known cross-sectional determinants. Remarkably, the Fama and French five-factor alpha on a long-short strategy based on PG is 0.73% per month. This strategy remains highly profitable even for the top 20% largest firms and the significant risk-adjusted returns can also be attained with long-only positions. PG either subsumes or largely weakens the predictive power of other well-known, earnings-based signals on future returns at short- and intermediate terms. The PG effect is consistent with firm-valuation models featuring persistent earnings growth and compensation for expected growth-rate risk. An augmented Fama and French three-factor model that includes a PG factor captures the momentum anomaly at least as well as other prominent factor models

Keywords: Profitability; Growth; Return Predictability; Stock Returns

JEL Classification: G11; G12

Suggested Citation

Sotes-Paladino, Juan M. and Wang, George Jiaguo and Yao, Yaqiong (Chelsea), The Value of Growth: Changes in Profitability and Future Stock Returns (May 2, 2019). 29th Australasian Finance and Banking Conference 2016; Asian Finance Association (AsianFA) 2018 Conference. Available at SSRN: https://ssrn.com/abstract=2819183 or http://dx.doi.org/10.2139/ssrn.2819183

Juan M. Sotes-Paladino

Universidad de los Andes, Chile ( email )

Chile

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

Lancaster University Management School ( email )

Department of Accounting and Finance
Lancaster University Management School
Lancaster, Lancashire LA1 4YX
United Kingdom
+44 1524 592 577 (Phone)

HOME PAGE: http://www.lancaster.ac.uk/lums/people/george-wang

New York University - Stern School of Business ( email )

44 West 4th Street
Suite 9-160
New York, NY NY 10012
United States

Yaqiong (Chelsea) Yao (Contact Author)

Lancaster University - Management School ( email )

Department of Accounting and Finance
Lancaster University Management School
Lancaster, LA1 4YX
United Kingdom

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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