The Other Side of Value: Good Growth and the Gross Profitability Premium

Robert Novy-Marx

Research

56 Pages

This paper argues that gross profitability is a powerful predictor of stock returns, rivaling book to market while identifying attractive growth companies. Profitable firms historically earned higher average returns despite lower book to market ratios, suggesting profitability can complement value and help distinguish good growth.

Key Takeaways

Profitability Predicts Returns: The most profitable firms earned 0.31% more per month than the least profitable firms, with a test statistic of 2.49.
Works In Large Caps: The largest stock portfolio typically held fewer than 350 companies while representing roughly 75% of total market capitalization.
Value Diversification Matters: From July 1963 through December 2010, the combined profitability and value strategy never experienced a losing 5 year period.
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