An Empirical Investigation of the Profitability Anomaly in the Indian Stock Market

Abstract

This study examines the profitability anomaly for the Indian stock market using data for 493 companies on the BSE from January 1996 to December 2010. A negative relation between profitability and returns is empirically confirmed which is in contrast to prior research for mature markets. Further the observed relationship is robust to choice of profitability measure. The findings can be explained by the fact that more profitable firms tend to give higher dividend payouts and are therefore perceived to be less risky by  investors resulting in lower returns. A positive relationship between profitability and payouts and a negative relationship between payouts and beta is obtained confirming our argument. The three factor Fama French model is able to explain returns on profitability sorted portfolios which was not fully explained by CAPM. Thus the profitability anomaly does not pose serious challenge to asset pricing in the Indian context. Our findings have strong implications for academicians as well as portfolio managers. The study contributes to equity market anomaly literature especially for emerging markets.