What Is More Important, Profitability or Growth?

Presented by: Dr. Andrew Stotz, CFA
What Is More Important
for Price Performance
Profitability or
Growth?

220 September 2016
Sources: A. Stotz Investment Research
 Hypothesis 1: High profitability in any one year
also results in coincident price outperformance
in that year
 Hypothesis 2: High growth in any one year also
results in coincident price outperformance in
that year
 Hypothesis 3: High growth is more important
than high profitability for price outperformance
Testing profitability, growth, and price performance

320 September 2016
 We started with our World Class Benchmarking
database consisting of 27,000 companies globally
 20 year time period (Mar 1997-Aug 2016)
 We removed financial companies, and was left
with 23,500 non-financial companies
 We removed 4,000 stocks that did not have the
fundamental data needed for the study
Preparing the universe

420 September 2016
 Each year we only included companies with a
market capitalization greater than US$500m
 To be included in any one year, the company
needed to have full-year price data in that year

520 September 2016
 To eliminate outliers, we excluded stocks that
had a price change of more than 500% or less
than -80% in any one year
 This left us with on average 4,500 stocks per year
(min = 1,500 and max = 8,400)

620 September 2016
 We used return on assets (ROA) to measure
profitability, and the companies in the top 3
deciles which had the highest ROA in each year
we called “high profitability” companies
 To test across sectors and size, we created our
“high profitability” portfolio by combining the
top 3 deciles which had the highest ROA in every
sector and from each size group
Test the coincidence between profitability and price performance

720 September 2016
 We measured the 1-year price performance
ending at each company’s closing period
compared to 1 year before
 Our “high growth” portfolio included on average
1,700 stocks per year (min = 400 and max = 2,900)
 Hypothesis 1: High profitability in any one year
also leads to coincident price outperformance in
that year
Test the coincidence between profitability and price performance

820 September 2016
772
342
-
200
400
600
800
1,000
1,200
1,400
High profitability
Universe
Mcap-weighted indices (USD)
High profitability companies generated more than double the market return
Sources: A. Stotz Investment Research, Thomson Reuters

920 September 2016
5
10
13
-
2
4
6
8
10
12
14
Universe High profitability High growth
Price return from Mar 1997 - Aug 2016Coincident return (%, p.a.)
High profitability companies averaged a return of 10% p.a.

1020 September 2016
(40)
(30)
(20)
(10)
-
10
20
30
40
50
High profitability Mcap-weighted universeCoincident return (%)
High profitability companies beat the market in every year… except one

1120 September 2016
This translates to 95% of the time over the past 20 years
95
90
50
55
60
65
70
75
80
85
90
95
100
High profitability High growth
Number of years that each group beats the
sector peers in the past two decades
Winning periods (%)

1220 September 2016
 We used EPS growth as our measure of growth,
and the companies in the top 3 deciles which
had the highest EPS growth in each year we
called “high growth” companies
 To test across sectors and size, we created our
“high growth” portfolio combining the top 3
deciles which had the highest EPS growth in
every sector and from each size group
Test the coincidence between growth and price performance

1320 September 2016
 We measured the 1-year price performance
ending at each company’s closing period
compared to 1 year before
 Our “high growth portfolio” included on average
1,300 stocks per year (min = 400 and max = 2,500)
 Hypothesis 2: High growth in any one year also
results in coincident price outperformance in that
year
Test the coincidence between growth and price performance

1420 September 2016
1,178
772
342
-
200
400
600
800
1,000
1,200
1,400
High growth
High profitability
Universe
Mcap-weighted indices (USD)
High growth companies generated more than triple the market return

1520 September 2016
High growth companies generated a return of 13% p.a. compared to
high profitability companies at 10% and the market at 5%
5
10
13
-
2
4
6
8
10
12
14
Universe High profitability High growth
Price return from Mar 1997 - Aug 2016Coincident return (%, p.a.)

1620 September 2016
(60)
(40)
(20)
-
20
40
60
80
High growth Mcap-weighted universeCoincident return (%)
High growth companies outperformed every year since 2000

1720 September 2016
This translates to 90% of the time over the past 20 years
95
90
50
55
60
65
70
75
80
85
90
95
100
High profitability High growth
Number of years that each group beats the
sector peers in the past two decades
Winning periods (%)

1820 September 2016
 “High profitability” companies generated more than
2X market return and “high growth” companies more
than 3X market return over the past 20 years
 “High growth” companies generated a return of 13%
p.a. compared to “high profitability” companies at
10%, during that time the market returned 5%
 “High profitability” companies beat the market 95%
of the time and “high growth” companies 90% of the
time
What we have learned

1920 September 2016
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What Is More Important, Profitability or Growth?

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