The profitability trend, or recent trajectory of a firm's profits predicts future profitability and stock returns. The profitability trend also predicts the earnings surprise one quarter later, and analyst forecast errors over the following twelve months, suggesting that sophisticated investors underreact to the information in the profit trend.
The profitability trend is the trend regression of the quarterly gross profit over the past eight quarters.
First, we calculate quarterly gross profit (GPQ) as quarterly sales minus quarterly cost of goods sold scaled by total asset, then we compute the level of quarterly gross profit for each firm as the average GPQ over the most recent 8 quarters. Finally, the trend in profits is measured using regression model.
Profitability Trend (PT) coefficient is calculated for each stock, and ranked from the highest to the lowest PT value. The ranking of PT is also normalized with Z-Score function.
We then divided the universe into 10 quantiles of stocks, with the top quantile (Q_10) representing the highest expected future productivity and profitability and the bottom quantile (Q_1) representing the lowest expected future productivity and profitability.
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