Best Firm Profitability Metric Worldwide?
June 6, 2017 - Fundamental Valuation
Which firm profitability metric best predicts stock returns? In their May 2017 paper entitled “Alternative Profitability Measures and Cross Section of Expected Stock Returns: International Evidence”, Nusret Cakici, Sris Chatterjee and Yi Tang compare abilities of 12 profitability ratios to predict stock returns across four regions (North America, Europe, Japan and Asia-Pacific). They consider three measures of profitability: gross profit (GP); operating income (OI); and, earnings before interest and taxes (EBIT). They consider four scaling variables: enterprise value (EV); book value of assets (BA); market value of equity (ME); and, book value of equity (BE). Specifically, at the end of June each year, they rank stocks by region into fifths (quintiles) based on each of the 12 profitability metrics and hold the quintiles for one year. They measure the predictive power of each metric as average monthly return to a portfolio that is annually long (short) the top (bottom) quintile. Using firm accounting data and monthly stock returns for 23 developed country equity markets allocated to one of the four regions during January 1991 through December 2016, they find that: Keep Reading