On the Conjoint Nature of Value and Profitability

Abstract

Novy-Marx (2013, 2014) argues that profitability and value are philosophically and economically related: buying highly productive firms at average prices is similar to buying average productivity firms at low prices. We investigate the risk and return of portfolios that hold the entire market but tilt towards the joint distribution of stocks that rank highly on both value and profitability. Over 1940-2019, such “tilted market portfolios” generate substantially higher returns than the pure market portfolio. Even in periods where value has delivered weak returns (2000-2019), tilted market portfolios offer attractive risk-reward ratios. For investors with long horizons, bootstrapped simulations of up to 30-year holding periods indicate that the entire distribution shifts further to the right, generating better outcomes for investors. We conclude that benefits to long-only investors come from targeting value and profitability jointly, rather than running them side-by-side or sprinkling one with the other.

Keywords: Value, Profitability, Asset Pricing, Factor Models

JEL Classification: G15