The Magic Formula: Value, Profitability, and the Cross-Section of Global Stock Returns

Vol. 19, No. 2, 2021

Douglas W. Blackburn and Nusret Cakici

Buying profitable, undervalued stocks and shorting unprofitable, overvalued stocks yields significant return differentials in North American, Europe, Japan, and Asia. Using data from 1991 to 2016, double sorting stocks into portfolios by gross profits, a measure of profitability, and earnings yield, a measure of value, yields significant abnormal returns for all size groups and in all global regions after controlling for size, book-to-market, momentum, profitability, and investments factors. Abnormal returns persist after accounting for transaction costs, are larger during high sentiment periods and are present across different sectors and countries.