Enhancement of value strategies using the profitability premium

Abstract

The profitability premium can enhance value strategies. The anomaly is still significant after adding a profitability- (RMW) and investment (CMA) factor to the (Fama & French, 1993, 2015) three factor regression. A combination of the four anomalies-- Book-to-Market Equity, Operating Cashflow, Gross Profit and Operating Profit-- in a Mean Variance Portfolio achieves significant out of sample returns compared to the market and other anomaly portfolios. This simple strategy realizes an annualized Sharpe ratio of 1.30 between July 1966 to June 2016 and is even significant after transaction costs. In addition, after implementing mutual fund restrictions (no short selling, minimum market capitalization) it still earns a significant monthly Alpha of 0.22% and is therefore suitable for retail- and institutional investors.