Research On The Effectiveness Of Value Investment Based On Gross Profit Index In The Chinese Stock Marke

Value investment pays attention to the valuation and profitability of the company,and gains profits through the dividend and return of the company’s value.In short,value investment means buying valuable stocks for investment.This paper starts with two aspects of value – profitability and valuation,and finds out the value of stocks from these two aspects.Profitability mainly reflects value from the company’s perspective.The stronger the company’s profitability,the higher its value.Valuation mainly reflects value from the perspective of investors.The lower the valuation level of the underlying company,the more valuable it is for investors to invest in the company.In the stock market,the purpose of value investment is to find stocks with strong profitability and low valuation.In the relevant research of American stock market,buying stocks with high profitability can get higher returns than buying stocks with low profitability.Buying stocks with low valuation can get higher returns than buying stocks with high valuation.The main content of this paper is to analyze the profitability of a company in A-share market by constructing profitability variables with different profit indicators,to measure the valuation degree of a company by constructing valuation indicators with different profit indicators,and to judge whether the value investment strategy is applicable in A-share market based on the profitability and valuation measured by different profit indicators.The precondition for the success of value investment strategy is to accurately measure the company’s profitability and valuation.Only under the condition of accurately measuring the company’s profitability and valuation can the future earnings of stocks be more accurately predicted.On the contrary,if the profitability variable can more accurately predict the future earnings of stocks,it shows that the profitability variable can more accurately measure the company’s profitability.If the valuation variable can more accurately predict future stock returns,then the more accurate the valuation variable is in measuring the degree of stocks’ valuation.To describe the company’s profitability,this paper selects gross profit to the book value of the company’s equity,operating profit to the book value of the company’s equity and net profit to the book value of the company’s equity as the profitability variables to measure the company’s profitability.In the aspect of describing the valuation degree of the company,this paper chooses gross profit per share to stock price,operating profit per share to stock price,net profit per share to stock price,and book-to-market ratio as the valuation variables to measure the valuation of the stocks.From the perspective of profitability,this paper measure the profitability of a company using gross profit to book value of equity,operating profit to book value of equity and net profit to book value of equity respectively.That is,the more gross profit can be generated by unit equity,the stronger the company’s profitability.For comparison,this paper also chooses operating profit and net profit to measure the profitability of a company,for there are many existing literature using operating profit and net profit to measure the profitability of a company.In the relevant literature of the American stock market,operating profit is often used to measure the profitability of a company,while in the existing domestic research,net profit is often used to measure the profitability of a company.From the perspective of valuation,this paper describes the degree of stock valuation by the ratio of gross profit per share to stock price,the ratio of operating profit per share to stock price,the ratio of net profit per share to stock price and the ratio of book-to-market.Taking gross profit as an example,the lower the ratio of gross profit per share to price,the higher the stock price supported by gross profit per share,which indicates that the stock of a company is more likely to be higher valued.Considering that many studies at home and abroad using book-to-market ratio in measuring the degree of stock valuation,this paper also use book-to-market ratio as a measure of the degree of stock valuation.Firstly,this paper study the predictive ability of profitability variables constructed by gross profit,operating profit and net profit.From the results,among the three profitability variables,the profitability variable constructed by gross profit has the strongest ability in predicting future stock returns.This paper then construct arbitrage portfolio with the three profitability variables by dividing the sample into different profitable portfolios.By comparing the average profitability premium of arbitrage portfolio constructed by three profit variables respectively,this paper find that the arbitrage portfolio constructed by gross profit can obtain the highest average profitability premium.In addition to using the difference between the average return of the high-profit portfolio and the low-profit portfolio to measure the profitability premium,this paper also use sharp ratio and risk-adjusted return to measure the profitability premium of the arbitrage portfolio based on these three profit variables.The results show that the profitability premium of the arbitrage portfolio based on gross profit variable is higher.Secondly,this paper study the explanatory power of gross profit per share to stock price,operating profit per share to stock price,net profit per share to stock price as well as book-to-market ratio to future stock returns.The results show that the valuation variable constructed by gross profit has stronger explanatory power to future stock returns.This paper divide the sample into different value portfolios according to these four valuation variables,and buy the lowest valuation portfolio and sell the highest valuation portfolio.This paper evaluate these four valuation variables by the average value premium of arbitrage portfolio constructed based on these four valuation variables.The results show that the arbitrage portfolio constructed based on gross profit can get the highest value premium.This paper also use sharpe ratio and risk-adjusted return to measure the value premium of the arbitrage portfolio based on these four value indicators,and the results show that the value premium of the arbitrage portfolio based on gross profit variable is the higheset.After obtaining the above results,this paper continues to study why the profitability variable of gross profit can more accurately measure the company’s profitability,and why the valuation variable of gross profit can more accurately measure the stock valuation.Starting with the expense items between gross profit and net profit.This paper decomposes the items between gross profit and net profit,and studies their ability in predicting future stock returns.The results show that sales expense and administrative expense show significant positive correlation with the future stock returns.Sales expense and administrative expenses are the effective information to predict the future stock returns.Compared with operating profit and net profit,gross profit contains more effective information that can predict the future stock returns,so gross profit has a stronger ability in predicting future stock returns.On this basis,this paper continues to study the reasons for the significant positive correlation between sales expense,administrative expense and future stock returns.This paper finds that sales expense and administrative expense are not only resource consumption,but also resource investment,which plays a positive role in promoting the company’s future performance.By dividing the samples into different portfolios according to the sales expense ratio and administrative expense ratio,this paper analyzes the future profitability and stock returns of each portfolio.It is found that the higher the average sales expense ratio or the higher the average administrative expense ratio,the stronger the future profitability and the higher the stock returns.This paper also analyzes the reason why the gross profit index can better predict the stock returns from the perspective of profit manipulation.Profit manipulation,also known as earnings management in academia,means that enterprises manipulate the publicly disclosed profit information through legal or illegal means to achieve the desired goal.If there is profit manipulation,the profitability variable constructed according to the disclosed profit can not accurately measure the profitability of the company,and the valuation variable constructed can not accurately measure the valuation of the stock.After controlling the profit manipulation,this paper finds that the ability of operating profit and net profit to predict future stock returns has improved to a certain extent,but it is still not as good as gross profit.In fact,since the gross profit is calculated directly based on the sales revenues and sales costs,there are fewer links subject to artificial adjustment.Compared with the operating profit and net profit,it is a purer profit index.Therefore,from the perspective of profit manipulation,it is a better choice to measure the company’s profitability and valuation based on the profitability variable and valuation variable constructed by gross profit.There are abundant studies on the application of Fama-French three factor model in China A-share market,but these studies have different conclusions on whether FamaFrench three factor model is applicable in China’s stock market.When comparing the prediction ability of different valuation variables to stock returns,it is found that the book-to-market ratio can not predict stock returns well in the A-share market,and the ability of valuation variable constructed by gross profit is stronger than book-to-market ratio in predicting future stock returns.Therefore,this paper constructs the value factor based on the gross profit,and compares the three factor model including the value factor constructed by gross profit with the traditional Fama-French three factor model,so as to judge whether the three factor model including the value factor constructed based on gross profit is more suitable for China’s stock market.In the research,this paper excludes the 30% sample with the smallest marketcap for two reasons.Firstly,this paper analyzes and compares the prediction ability of the constructed profitability variables and valuation variables on the future stock returns in different marketcap samples,and finds that in the small marketcap samples,these profitability variables and valuation variables can not predict the future stock returns well;Secondly,Liu et al.find that the unique IPO mechanism in A-share market led to the existence of shell value effect,which destroyed the ability of mainstream factors to explain stock returns in asset pricing.This paper finds that before excluding the 30%sample with the smallest marketcap,the three factor model based on book-to-market ratio and the three factor model based on gross profit have not passed the GRS test.After excluding the 30% sample with the smallest marketcap,although the three factor model based on book-to-market still fails to pass the GRS test,the three factor model based on gross profit and the three factor model based on net profit pass the GRS test,and the three factor model based on gross profit has better explanatory ability than the three factor model based on net profit.The results of this paper show that profitability premium and value premium in the American stock market also exists in the A-share market.However,in the selection of profitability variable and valuation variable,the results of this paper are different from those of relevant studies in the United States.China A-share stock market is an emerging market,which has many differences with developed markets such as the United States in terms of investment environment,regulatory system and investor maturity.Therefore,some conclusions established in the stock market of United States are not necessarily established in A-share stock market,which need to be revised according to the characteristics of the Chinese stock market.