5 Jun, 2018
Capital Markets
The (Gross Profitability) Trend Is Your Friend
Highlights
In this report, we examine the performance of a trend strategy derived from gross profitability (“GP”).
Gross profitability trend was effective across multiple investment style categories.
Trend strategies based on changes in stock price or earnings are widely used by investors. In this report, we examine the performance of a trend strategy derived from gross profitability (“GP”). Gross profitability trend (“GPtrend”), was proposed by Akbas et al. who argued that the trajectory of a firm’s profitability is just as important as the level (GP). We define GPtrend as the year-on-year difference in either quarterly or trailing twelve month GP, where GP is calculated as revenue minus cost of goods sold, divided by total assets. Our back-tests confirm that GPtrend has historically been an effective stock selection signal globally, with the added benefit of low to moderate correlation with commonly used investment strategies. Our findings include:
• GPtrend generated statistically significant average annualized long-only and long-short excess returns in five of the six regions we tested the signal. Performance was strongest (long-short basis) in Asia ex-Japan (6.68%), Europe ex-U.K. (6.66%) and the U.S. (6.50%), and weakest in Japan (1.15%).
• Gross profitability trend was effective across multiple investment style categories, indicating that the factor can be beneficial to a value, growth or core and large/small cap investment process.
• GPtrend’s performance is not subsumed by gross profitability, earnings revision or price momentum: GPtrend retains its ability to separate winner stocks from loser stocks, after controlling for GP. The average annualized return of the most attractive GP/GPtrend interaction portfolio minus the least attractive interaction portfolio is 12.19%. The factor’s excess return is also still significant after controlling for both earnings and price momentum.
• Performance was robust to several methodologies of determining trend: We computed gross profitability trend using six different methods and all six trend metrics generated statistically significant average annualized long-short excess returns in the Russell 3000 universe.