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Evidence on Profitability, Risk, Growth, and Stock Returns

Article Quant Q&A · Author: Philip
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Summary

The answer surveys research linking firm profitability, risk, and growth or value characteristics to stock returns. It cites studies associating profitability and operating income growth with firm quality and future returns. For risk, it summarizes findings connecting idiosyncratic volatility and cash flow variability to average returns, including evidence that lower-volatility stocks can outperform higher-volatility stocks. It also contrasts international evidence for value-stock premiums with research questioning whether growth stocks deliver faster future cash flow growth.

The cited strands treat these characteristics separately; the answer says it knows of no study combining all three simultaneously. It therefore does not provide the requested weighted-average scheme or establish how to weight the factors, and it cautions that the suggested literature may not be current. These findings are literature summaries rather than a unified causal model, so definitions, samples, time periods, and differences across industries would need examination before applying them in a factor strategy.

Key ideas

  • Research links profitability to firm quality and, in cited studies, higher future returns.
  • Some cited evidence associates lower idiosyncratic volatility with higher average stock returns.
  • The answer reports a value premium while questioning whether growth stocks have higher future cash flow growth.
  • The cited research treats the factors largely in separate strands and does not specify a combined weighting scheme.
  • The findings require updates and context before use in an investment model.

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# Literature on return sensitivy in respect to: growth, risk and profitability


# Literature on return sensitivy in respect to: growth, risk and profitability












I am currently writing my master's thesis, wherein I am looking for supporting literature. Specifically, I wanted to know if there had been any research relating to how the: growth, risk and profitability each individually affects the return? Maybe the return for firms in some industries is driven more by growth prospectives, rather than profit, or vice versa?

I'd like to know because I am trying to establish a weighted average scheme, which should consider all 3 factors.

## Answer by skoestlmeier (score 2, accepted)

https://quant.stackexchange.com/a/43641

There are several strands of literature on each of your variables of interest (growth, risk and profitability), but to my best knowledge, no one deals with all of them simultaneously (your research may be quite interesting though!). So let me recommend the following papers and how they connect some of your firm variables:

- Profitability and operating income growth are important determinants for investors' perception of firm quality, which is documented by McGuire et al. (1990). This is studied in Fama/French (2006), who show that firms with higher profitability earn higher future returns. In a broader study, Bali et al.(2008) finds a strong time-series and cross-sectional return predictability of profitability.

- Risk, in terms of idiosyncratic volatility, is studied in Ang et al. (2006), who finds that low volatility stocks have higher average returns than high volatility stocks. Huang (2009) shows that average returns decrease with higher levels of cash-flow variability and that this is closely related to the idiosyncratic volatility in average returns. Irvine and Pontiff (2009) find that the increase in idiosyncratic volatility over time is associated with an increase in the cash flow variability.

- Fama/French (1998) find, that value stocks have higher returns than growth stocks in markets around the world. However, Chen (2017) provides evidence, that contrary to conventional wisdom, growth stocks do not have substantially higher future cash-flow growth rates than value stocks.

However, the papers above are mainly opinion-based. I have tried to suggest high-ranking and thus outstanding studies, though they might not be the most current ones. For this reason, you may look at Google Scholar and search for current papers, citing the research papers above.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

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