Combining Value and Profitability Factors to Improve Performance

Abstract

The value and profitability factors are widely used by both academics and practitioners. Studies of their properties have tended to focus on them separately. This article considers the results of combining these two factors. We find that portfolios formed on the intersection of stocks with both high value and profitability characteristics outperform portfolios with moderate characteristics, which in turn outperform portfolios of stocks with low characteristics. These results are persistent, pervasive, robust, investable, and intuitive, giving us greater faith in their continuing efficacy. We also show that, in contrast to the traditional value measure of book to market, value metrics using earnings and cash flow provide significant exposure to profitability and thus act as a useful complement.