Combining Profitability, Growth, and Cash Flow in Equity Portfolios

Summary

This study compares equity portfolios selected on profitability, growth, and cash flow, then tests combinations of these fundamentals. It reports quarterly rebalanced results against the CSI 300 from 2013 through June 2021. Each standalone top-50 factor portfolio outperformed the benchmark over that period, while a portfolio requiring strength across all three dimensions produced higher annualized returns and more stable yearly excess returns.

The factors had low correlations in their excess-return time series, suggesting diversification benefits. Yet stocks strong on all three measures were rare: after controlling for profitability, growth and cash flow showed a slight negative relationship, plausibly because fast-growing firms invest more and retain less free cash flow. Two-factor portfolios broadened the investable set while still outperforming the benchmark in the reported backtest. Profitability alone also performed strongly, particularly in later years. These results are historical and model-generated; the document warns of model misspecification and factor decay, and provides no evidence that the returns will persist.

Key ideas

• Standalone profitability, growth, and cash flow portfolios each outperformed the CSI 300 in the reported backtest.
• The three factors had low excess-return correlations, so combining them may smooth yearly results.
• Stocks ranking highly on all three fundamentals were scarce, partly because growth and cash flow were slightly negatively related after controlling for profitability.
• Two-factor combinations expanded portfolio breadth while retaining positive benchmark-relative performance in the study.
• The reported results may reflect model misspecification or factors that later stop working.

Tags

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.