ROE, defined as the earnings-to-book-value ratio, is frequently used in practitioner settings to identify high-quality stocks. There is very little evidence of any premium associated with profitability.
To further examine factor robustness, we explored the change in the measured factor premium due to small changes in the factor definition/construction. For example, we changed the value signal from book-to-price to earnings-to-price and changed the momentum signal from a 12-month look-back to a 6-month look-back. In Table 3, we report the impact on the factor premium arising from reasonable variations in factor definitions.
Smart Beta In The Factor Zoo
The smart beta movement makes it particularly important to understand this zoo of factors and how best to capture factor premia in an equity portfolio.