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Some money managers are getting excited by the latest holy grail for investors - using gross...

Some money managers are getting excited by the latest holy grail for investors - using gross profitability as a basis for picking stocks. Research from University of Rochester's Robert Novy-Marx shows that cheap "quality" plays outperformed the overall market by over four percentage points a year from 1963-2011. "You get much more informative signals about the health of firms" this way, says Novy-Marx.
Comments (20)
  • bbro
    , contributor
    Comments (9834) | Send Message
     
    Ok Apple has 55 billion in gross profits and 176 billion in assets....
    55/176 = .3125 ....Exxon has 78 billion in gross profit 334 billion in assets
    78/334 =.2335....Do I buy Apple instead of Exxon??
    3 Mar 2013, 10:16 AM Reply Like
  • Brendan O'Boyle
    , contributor
    Comments (1115) | Send Message
     
    Assuming AAPL has sustainable earnings you buy AAPL. But tech could be tricky because their moat could erode.

     

    This is why you will never have a computer solve some equation to pick the best stocks. You need someone to read the quarterly reports figure out where the company is headed and balance that against the raw data. A data driven screener can help, but ultimately it is the investor who must determine if the company is really a buy.

     

    BTW, this is why most of the money for data driven buying and selling goes to HFT. In the short term the market lacks much rationality, which is why a computer can beat a human. In the long term not so much...
    3 Mar 2013, 02:04 PM Reply Like
  • Petrarch
    , contributor
    Comments (766) | Send Message
     
    yes as long as the price to book is less than 1.7 - according to them. I like 2 as a general rule - 1.7 is a weird number - feels like a data mining output.
    the whole thing could have been an exercise in data mining - the .33 also feels like a magic number - why that and not .4 for example

     

    P
    3 Mar 2013, 02:49 PM Reply Like
  • Brendan O'Boyle
    , contributor
    Comments (1115) | Send Message
     
    I enjoyed this bit:

     

    "Picking stocks this way isn't something you could pull off on a weekend morning in your pajamas. For each potential investment, you would need to subtract the company's cost of goods sold from its revenue, then divide by its total assets."

     

    Actually, I think subtracting and then dividing is something I could pull off on a weekend morning in my pajamas : P
    3 Mar 2013, 04:54 PM Reply Like
  • Tom Armistead
    , contributor
    Comments (5410) | Send Message
     
    As others have pointed out, it's pretty easy to develop something that will backtest to the point of beating the market by 4%. Going forward, not so easy.

     

    Focus on gross profit is a starting point: from there it's important to look at what is being done with the resulting cash flows. Capex sometimes pressures stock prices because investors prefer free cash flow. But take for example Verizon (VZ), they did a lot of capex on FiOS and 4G wireless, eventually it drove the stock higher. R&D is similar, but very hard to quantify, it should result in higher gross margins if innovative products are being developed on a regular basis.

     

    Some companies seem to report lower profits as a percentage of cash flow, or of gross profits. Aggressive deprecitaion and amortization can reduce reported earnings, but the cash can be put to good use.

     

    Another thing with backtesting, the models usually include rebalancing at regular intervals. The equal weight S&P 500 outperforms the regular version, partly because of the rebalancing.
    3 Mar 2013, 07:18 PM Reply Like
  • Heinz Doofenshmirtz
    , contributor
    Comments (273) | Send Message
     
    I prefer the (wiseguy) term "hindcast" to "backtest".
    3 Mar 2013, 07:58 PM Reply Like
  • Deja Vu
    , contributor
    Comments (1287) | Send Message
     
    OK, CRM is going to hit $1000 then.
    3 Mar 2013, 10:27 AM Reply Like
  • bbro
    , contributor
    Comments (9834) | Send Message
     
    CRM -96 million in gross profit...4 billion in assets...AMZN 676 miilion
    in gross profit...32.55 billion in assets....yikes....
    3 Mar 2013, 10:34 AM Reply Like
  • bbro
    , contributor
    Comments (9834) | Send Message
     
    GOOG 12.7 bill to 94 bill
    3 Mar 2013, 10:57 AM Reply Like
  • bbro
    , contributor
    Comments (9834) | Send Message
     
    Another Bernanke attack??? Moving along class... now about Gross
    Profitablity to Assets...
    3 Mar 2013, 11:28 AM Reply Like
  • Brendan O'Boyle
    , contributor
    Comments (1115) | Send Message
     
    I read this article in the WSJ Intelligent Investor column.

     

    I fail to see what the excitement is about. Earnings quality is basically just adjusting for depreciation and R&D spending. Any standard DCF model should take these factors into account.

     

    So yes, all thinks equal a low P/E stock in a highly capital intensive industry is worth less. And a company that spends much on R&D is worth more than the TTM P/E might indicate.

     

    This is stating the obvious...
    3 Mar 2013, 11:29 AM Reply Like
  • davidbdc
    , contributor
    Comments (3165) | Send Message
     
    Money managers looking for the 'easy path' to riches.......

     

    Yeah, there is something new

     

    Manage your own money!
    3 Mar 2013, 11:57 AM Reply Like
  • deercreekvols
    , contributor
    Comments (5706) | Send Message
     
    I am hoping that this source is from University of Rochester in Rochester, NY.

     

    There is no such place as Rochester University. There is a Rochester College in Michigan.

     

    I know this is nit-picky, but....

     

    So- Where in the world is Carmen Sandiego?
    3 Mar 2013, 01:35 PM Reply Like
  • Petrarch
    , contributor
    Comments (766) | Send Message
     
    DFA
    Bill Bernstein
    Cliff Assness
    are mentioned - these are credible people

     

    interesting that this is also a Buffet metric this gross profit efficiency idea

     

    An interesting screen

     

    P
    3 Mar 2013, 02:45 PM Reply Like
  • silence_twain
    , contributor
    Comments (339) | Send Message
     
    I have never seen an investment startegy which did not work in a back tested fashion, but I have seen many which have failed once they were taken out of the back tested mode and put into practice.
    3 Mar 2013, 03:33 PM Reply Like
  • dieuwer
    , contributor
    Comments (2409) | Send Message
     
    Why 1963-2011? How about 1929-1945.
    3 Mar 2013, 03:50 PM Reply Like
  • Snoopy1
    , contributor
    Comments (1115) | Send Message
     
    So is the screen gross profit/enterprise value or gross profit/total assets?

     

    Also, can someone suggest the best free website that allows for this screen?
    3 Mar 2013, 03:58 PM Reply Like
  • Herr Hansa
    , contributor
    Comments (3080) | Send Message
     
    I often look at a different variation of this idea, which is gross revenues to market cap. Obviously, as others have stated, there remains a need to further investigate a company to see where they are headed.
    3 Mar 2013, 04:50 PM Reply Like
  • Jeremy Johnson, CFA
    , contributor
    Comments (783) | Send Message
     
    GAAP net earnings are a poor metric of future cash generation. There are lots of improvements you can make to it to add value. Four percent over 10 years is 50% more return -- would fix the pension problems plus some for any large American industrial company and is very significant.
    3 Mar 2013, 08:43 PM Reply Like
  • dividend_growth
    , contributor
    Comments (2895) | Send Message
     
    You want to minimize P/E and maximize E/A.

     

    Or simply put, find the company with the largest ROA/(P/E).
    3 Mar 2013, 08:49 PM Reply Like
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