Strong profitability-based strategies historically outperformed Nifty returns: Capitalmind study

The study highlights that, even amid elevated valuations, profitability strategies remain a strong contender for long-term growth.

Strategies that focus on profitability metrics, such as gross profits to assets and return on equity not just offer a scalable approach to quality investing but have also outperformed Nifty returns on a historical basis, a recent study by Capitalmind Financial Services showed.

These factor strategies, which include factors like momentum, profitability, value, and low volatility, involve selecting stocks based on specific characteristics and consistently applying these criteria to build diversified portfolios.

The study’s results showed that factor strategies based on profitability metrics have historically outperformed the Nifty 50 index, regardless of the sub-par performance in recent years. Results from the study showed that a Rs 100 investment in the profitability-factor portfolio based on a

composite measure in July 2007 would have grown to Rs 1,765 today, providing an annualized return of 17.9 percent, compared to Rs 810 with an annualized return of 12.8 percent in the Nifty

50.

The Capitalmind study highlights that highly profitable companies generate surplus capital, enabling faster and more predictable business growth. These companies, that rank high on profitability, tend to showcase characteristics like strong competitive advantages and lower dependence on external funding that usually bodes well with investors.

Meanwhile, another key observation from the study states that profitability-based strategies typically tilt towards defensive sectors since these offer resilience even during economic downturns or phases of market corrections, helping in portfolio amidst volatility.

Moreover, these profitability strategies also prove to hold long-term potential despite recent high valuations. However, the study did hint that elevated valuations have led to more modest returns in recent times and hence suggests integrating profitability with other factors to help mitigate performance fluctuations.

As for the use of these profitability strategies by Indian investors, Divyansh Agnani, Research Analyst at Capitalmind Financial Services, stated that  while globally, profitability factor investing is well-established, India has yet to fully explore its potential.

"Of the Rs 30,778 crore invested in style-based passive mutual funds, only Rs 1,817 crore is allocated to Profitability or Quality-styled funds. This is surprising, given the demand for Quality funds in active investing. Our analysis indicates that high valuations—something active fund managers can counteract—may be a key reason for this gap,” Agnani said.