On April 2, global equity markets were shocked by President Trump’s Liberation Day tariff announcements. At that time, I wrote to investors asserting that there were reasons for optimism and that maintaining equity allocations was likely to be rewarded in the coming years.[1] Since that article, global stocks, as measured by the MSCI ACWI, have erased Liberation Day losses, closing the third quarter up more than 18 percent for the year. Of note, over this period, low profitability stocks have led the way, resulting in a negative profitability premium.
The profitability premium refers to the tendency for stocks with stronger, more consistent profits to outperform stocks with low or negative profits. For decades this premium has been observed across global equity markets and long-term investors have been rewarded for incorporating its implications in their investment strategies.[2] The premium tends to be more consistent over longer time horizons and less consistent over shorter horizons. The table below shows the frequency with which a positive profitability premium appears over rolling six- and sixty-month periods.
Table 1: Frequency of Positive Profitability Premiums through September 2025[3]
| U.S. Large | U.S. Small | Developed ex- US Large | Developed ex- US Small | |
| Data Set Begins | 7/1/1963 | 7/1/1963 | 7/1/1990 | 7/1/1990 |
| Rolling 6-month periods | 58% | 63% | 62% | 77% |
| Rolling 60-month periods | 71% | 74% | 92% | 100% |
The less consistent nature of the profitability premium over the shorter time horizons does not surprise us. Short-term bursts of investor sentiment can push prices in an irrational way; it can be exciting to chase returns in companies without profits. Still, over the long term, company fundamentals drive returns, and we continue to expect companies with higher profitability to outperform their less profitable peers. What surprises us today is the magnitude by which high profitability stocks have underperformed their low profitability or unprofitable peers. The table below provides historical context for periods in which the profitability premium has been negative.
Table 2: A Historically Rare Profitability Premium for the Six Months Ending September 2025[3]
| U.S. Large | U.S. Small | Developed ex- US Large | Developed ex- US Small | |
| Profitability Premium | -23.56% | -26.67% | -13.44% | -4.54% |
| Historical Percentile Rank | 2.0% | 1.2% | 3.3% | 4.7% |
Statistically, the period ending September 2025 was one of the profitability premium’s worst six-month stretches. It is even worse than the six-month period ending December 1999, which at the height of the dot-com speculative craze saw a -15.43 percent profitability premium within U.S. large caps. Our clients know that we often incorporate a modest tilt toward high profitability stocks when we design the equity portion of their portfolios. Our active tilt toward high profitability is designed to capture a long-term premium relative to global benchmarks. Given this recent, rare statistical event, portfolios that lean into high profitability stocks have faced headwinds. So how are we proceeding with portfolio construction?
Over longer horizons, tilting toward high profitability stocks has delivered positive premiums more frequently. We do not believe that long-term investors should abandon their high profitability tilts in favor of owning stocks with relatively low or even negative profitability. This is particularly the case with U.S. small caps, as more than 40 percent of the Russell 2000 index is made up of non-profitable companies. We also believe capital markets often return to long-term trends after periods of dislocation.
Since July 1963 there have been 15 other six-month periods where the profitability premium for U.S. large caps has performed worse than it did from April through September 2025. Table 3 below addresses these periods and subsequent 60-month returns. On average, the profitability premium delivered more than 6 percent compound annualized outperformance over those 60-month periods. As such, we believe that high profitability stocks are positioned well for strong future returns given the magnitude of their recent short-term underperformance.
Table 3: Profitability Premiums: Poor Short-Term Periods and Subsequent Returns[3]
| Period Ending | Trailing 6-Months | Subsequent 60-Months |
| Dec 1973 | -27.68% | 0.80% |
| May 1981 | -25.54% | 1.77% |
| April 1993 | -32.90% | 4.31% |
| May 1993 | -27.71% | 4.38% |
| June 1993 | -25.86% | 4.60% |
| July 1993 | -26.07% | 6.63% |
| Aug 1993 | -24.67% | 7.94% |
| Mar 1999 | -28.34% | 11.74% |
| April 1999 | -32.18% | 12.84% |
| May 1999 | -25.12% | 12.15% |
| Feb 2000 | -27.22% | 15.10% |
| July 2009 | -23.63% | -0.26% |
| Aug 2009 | -38.08% | 0.59% |
| Jan 2013 | -25.00% | 4.70% |
| Feb 2013 | -23.94% | 5.92% |
| Sept 2025 | -23.56% | ?? |
| 15 period average | 6.21% |
[1] The Markets Today: Reasons for Optimism at https://hbkswealth.com/insights/the-markets-today-reasons-for-optimism/
[2] Specific examples include Profitability, Growth, and Average Returns by Eugene F. Fama and Kenneth R. French and The Other Side of Value: Good Growth and the Gross Profitability Premium by Robert Novy-Marx. You can find these papers at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=570343 and https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1598056
[3] HBKS calculated these figures using data from the Kenneth R. French – Data Library. We used the “25 Portfolio Formed on Size and Operating Profitability (5×5)” data sets for U.S. and Developed ex US markets. The large cap profitability premium is represented the difference in returns for the “Big HiOP” and “Big LoOP” portfolios. The data is interpreted as the performance difference of the highest and lowest quintile of stocks sorted by operating profitability within the highest quintile of stocks sorted by market capitalization. The small cap profitability is represented the difference in returns for the “Small HiOP” and “Small LoOP” portfolios. The data is interpreted as the performance difference of the highest and lowest quintile of stocks sorted by operating profitability within the lowest quintile of stocks sorted by market capitalization. The frequency of positive profitability premium is the number of rolling periods in which the profitability premium is positive divided by the total number of rolling periods in the sample. Periods greater than 12 months are compound annualized. For more information on the data and methodology used in the Kenneth R. French – Data Library please visit https://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html
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