The Magic Formula: Value, Profitability, and the Cross Section of Global Stock Returns
39 Pages Posted: 22 Apr 2017 Last revised: 29 Oct 2017
Date Written: October 4, 2017
Buying profitable, undervalued stocks and shorting unprofitable, overvalued stocks yields significant return differentials in North America, Europe, Japan, and Asia. Using data from 1991-2016, we test Greenblatt’s (2006) “Magic Formula” (MF) and find that a modified MF which uses gross profits as a measure of profitability yields significant abnormal returns for all size groups and in all regions. Results from double sorts and Fama-MacBeth regressions show that MF explains the cross-section of returns in addition to size, book-to-market and momentum.
Keywords: return predictability, profitability, value, magic formula, cross-section of returns
JEL Classification: F21, F30, G10, G11, G12, G15
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