One of the most celebrated quality signals in finance beat the market here. Its ranking, though, barely worked.
Gross profitability is an academic star: the metric said to capture quality better than any other, and to be, in the end, just another form of value. On a decade of Indian data the screen did beat the index. But when we asked it to actually sort good stocks from bad, the famous signal went quiet.
Rank every company on how much gross profit it earns on its assets and on how cheaply it trades, and buy the best of both. It made about 18% a year against the market's 13.9%, roughly ₹53 lakh from ₹10 lakh. A clear win, and a vindication of the idea that profitable, cheap companies do well. The trouble only appears when you ask the screen to do the one job a ranking exists for.
Did the celebrated signal actually sort?
Barely. Sort every stock into ten buckets by the combined profitability and value score, and the returns refuse to line up. The best scoring bucket was not the best performer; middling buckets led; the staircase is more of a scramble. The rank correlation came in around −0.33, weak enough to call mostly noise. It is the same quiet failure we found in the Magic Formula: stack two sensible factors and the fine ranking they produce can carry far less information than the theory promises.
So where did the market beating return come from?
If the ranking did not pick the winners, something else earned the money. The answer is breadth. Owning a wide basket of profitable, sensibly priced companies simply did well over a decade that rewarded solid businesses, whether or not the screen could tell the very best from the merely good. The gross profitability idea worked as a quality gate, keeping you among decent companies, and failed as a fine ruler for ranking them. That distinction matters enormously for how you would use it.
A good idea, and a lesson in how to use it
None of this makes gross profitability a bad metric. Novy-Marx was onto something real: profitable, cheap companies did beat the market, and when we paired the same profitability measure with momentum in a separate test, it did real work. The catch here is precision. Treated as a fine ranking, a way to say this stock is better than that one, the signal was close to noise. Treated as a filter, a way to stay among quality names while you bet on something else, it earns its place. Knowing which of those two things a factor actually does, for the market you invest in, is exactly what checking reveals and reputation hides.
So we took it to Krest, and ran it through the whole test.
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Every figure on this page came from a few clicks on Krest. See this exact analysis live and interactive, or point the same test at any strategy you have ever believed.
For education only. Not investment advice or a recommendation to buy, sell, or hold any security, strategy, or product. Past performance does not guarantee future results, and all investing carries risk, including the possible loss of capital. Make your own decisions, and consider consulting a SEBI registered investment adviser.
Best effort analysis. Prepared on a best effort basis from historical data and may contain errors, omissions, or assumptions. Shared for information and discussion only, and should be independently verified before you rely on it. Krest accepts no liability for any decision made or loss incurred based on it.
Figures reflect a gross profitability and value screen (ranked by gross profit to assets and earnings yield, market cap above ₹1,000 cr), reconstructed yearly over the last ten years of Indian data (since June 2016), measured against the Nifty 500 total return index. The gross profitability factor was documented by Robert Novy-Marx (2013).
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