More profitable firms earn higher returns — even holding valuation fixed.
Novy-Marx · Journal of Financial Economics · published 2013 · original sample 1963–2010 (reported ≈ +4.3%/yr, t ≈ 3.2)
Growth of $1 in the long-short strategy, gross of trading and shorting costs. The dashed line marks the year the paper was published — everything to its right is out-of-sample.
$1 in the long-short strategy, gross of costs. Grey = the sample the paper had; blue = everything since.
The comparison the site is built around.
| Window | Return/yr | Vol | Sharpe | t-stat | Max DD |
|---|---|---|---|---|---|
| Paper's sample (1963–2010) | +3.0% | 7.9% | 0.42 | 2.6 | -42% |
| After publication (2014–2026) | +1.9% | 8.5% | 0.26 | 1.1 | -26% |
| Full sample (1963–2026) | +2.7% | 7.9% | 0.38 | 2.8 | -42% |
Is there a risk-adjusted alpha left once you control for the standard factors? Alpha is annualized; t-stats use Newey–West standard errors.
| Model | Alpha/yr | Alpha t | R² | Biggest loadings |
|---|---|---|---|---|
| CAPM (market only) | +3.7% | 3.3 | 0.04 | Mkt-RF -0.10 |
| Fama–French 3-factor | +3.7% | 3.3 | 0.13 | SMB -0.23, HML +0.06, Mkt-RF -0.05 |
| Fama–French 5-factor | 0.0% | 0.0 | 1.00 | RMW +1.00, Mkt-RF +0.00, SMB +0.00 |
| FF5 + momentum * | 0.0% | 0.0 | 1.00 | RMW +1.00, Mkt-RF +0.00, SMB +0.00 |
| FF5 + mom, own factor removed | +3.9% | 4.1 | 0.14 | tests for anything left beyond the other five |
* Profitability (gross / operating) is itself the RMW factor, so its alpha against a model that contains RMW is zero by construction — the informative row is the one with its own factor removed.
Trailing 3-year Sharpe ratio. Long stretches below zero are common.
| 1960s | +1.4%/yr | Sharpe 0.25 |
| 1970s | -0.6%/yr | Sharpe -0.11 |
| 1980s | +4.9%/yr | Sharpe 0.97 |
| 1990s | +2.3%/yr | Sharpe 0.39 |
| 2000s | +8.3%/yr | Sharpe 0.62 |
| 2010s | +1.4%/yr | Sharpe 0.26 |
| 2020s | +2.8%/yr | Sharpe 0.26 |
Profitable firms have more of their value in distant, riskier cash flows (long-duration equity), so they carry a higher discount rate.
Investors under-appreciate how persistent high profitability is and how quick the market is to punish unprofitable 'story' stocks.
Young — published 2013 — so the out-of-sample window is short, but it has held up and it is the natural hedge to value (buy cheap AND profitable). Now embedded in the Fama–French 5-factor model.
Long-short = the published Fama–French / Carhart factor return. Value-weighted, US equities, monthly, gross of transaction and shorting costs. The original-paper figures are approximate and annualized for comparison.