Understanding Dimensional’s Value Proposition, Part 3 of 7: Profitability
By Peter C. Thoms, CFA (LinkedIn Profile)
Do the stocks of companies with high profitability deliver better investment returns than the stocks of low profitability companies? If so, is it possible to take advantage of this factor cost-effectively in a broadly diversified, low-turnover investment portfolio?
For more than 30 years, Dimensional Fund Advisors (DFA) has pursued higher returns through in-depth research into asset pricing to find out which attributes of stocks suggest higher future returns. Dimensional, despite being one of the most respected and rapidly growing fund companies in the U.S., is relatively unknown to many investors. The firm does virtually no public advertising and only permits access to its funds through investment managers with whom it chooses to partner.
Our series of articlesof which this is the thirdendeavors to explain Dimensional’s strategies in plain terms and describe why we believe Dimensional funds offer an excellent value proposition and are therefore worthy of consideration by all investors. We encourage investors interested in Dimensional to read each piece in this series to gain a more in-depth understanding of the firm’s evidence-based investment strategies.
Read Part 1 of 7: Value Tilt, here.
Read Part 2 of 7: Small Cap Tilt, here.
Dimensional, by pouring through decades worth of pricing data from stock markets around the world, seeks to identify certain attributes, or “dimensions,” of stocks that suggest higher future return potential. I have described two such dimensions, the Value Premium and the Size Premium, in previous posts. This post describes the Profitability Premium.
The Profitability Premium is the newest dimension. Dimensional began to incorporate the metric into portfolios in the second half of 2013. In order for Dimensional to employ a dimension in the construction of real money portfolios, that dimension must be pervasive across markets, persistent across time periods and cost-effective to capture in diversified portfolios.
Dimensional’s research has found that in U.S. markets, as well as in developed and emerging international markets, that the stocks of companies with high profitability have delivered significantly better returns to investors than the stocks of low profitability companies. This has been the case across the majority of time periods as well. Also, because the profitability of individual companies is fairly consistent through time, employing the profitability dimension in portfolios does not require increased tradingmerely holding a higher weight in the stocks of high profit companies. Finally, another benefit the stocks of high profitability stocks have provided over low profitability stocks has been lower stock price volatility. Higher returns, coupled with lower volatility, make profitability a promising new dimension to employ in portfolios.
In recent decades, computers (and the uploading of historical financial data into computers) have allowed financial market researchers to process ever-larger amounts of information in a quest to understand the sources of higher returns in markets. Profitability is the most recent dimension, but will probably not be the last.
To learn more about Dimensional funds and how we employ them to construct low-cost, tax-efficient, value-focused portfolios for our clients, please visit us at: www.orionportfolios.com
For information and performance details about any particular Dimensional fund, please visit www.dfaus.com and click on “Strategies.”
Peter C. Thoms, CFA
Orion Capital Management LLC
1330 Orange Ave. Suite 302
Coronado, CA 92118
Tel: 619.435.1701
Email: [email protected]
About the Author:
Peter C. Thoms, CFA, is the founder and managing member of Orion Capital Management LLC, an independent Registered Investment Advisor based in Coronado, California. The firm manages assets for individuals, families, trusts, corporate pension plans and non-profit organizations.
Disclosure:
This document is for informational purposes only. Nothing in this report is to be construed as a specific investment recommendation. This document does not constitute the provision of investment advice, which is only provided by Orion Capital Management LLC under a written investment advisory agreement and only in states in which Orion Capital Management LLC is registered or is exempt from registration requirements. Orion is not a tax advisor and does not provide tax advice. For tax advice individuals should consult their CPA.
