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Rekenthaler Report

Do Profitable Companies Outperform?

Perusing finance, economics, and law.


One of the newest academic investment strategies is to seek companies that have high levels of profits. Finance professors have previously identified value, size, momentum, and liquidity factors (among others) as helping to explain stock-market returns. Now, some argue profitability--also called quality, defensive, or even "Buffettesque" factors--should be added to the list. According some academic research, buying companies that have high levels of profits leads to higher future returns. 

That seems to be basic common sense, right? Buying better companies leads to better future performance. However, investment experience teaches otherwise. Generally, buying the stocks of attractive companies, as measured by earnings or revenue growth, leads to worse returns than does buying the stocks of the dogs. Good companies are easy to own, which tends to make them overpriced. Understanding this counterintuitive finding is a key distinction between the beginning and intermediate fund investor.

John Rekenthaler does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.