A new research paper from Dimensional Fund Advisors (Ahn et al., October 2026)1 offers one of the cleaner empirical unifications in recent factor-investing literature: profit growth and price momentum are not competing explanations for expected returns. They are complementary signals pointing at the same underlying economic reality, and combining them improves an investor's ability to forecast future profitability and returns across global markets.
The research team, led by Senior Researcher Byung Hyun Ahn, PhD, alongside Tom Lord, Mia Huang, Namiko Saito, Stanley Black, and Co-Chief Investment Officer Savina Rizova, grounds the entire inquiry in valuation theory. The logic is straightforward. Expected future cash flows drive expected returns. Future profits equal current profits plus expected growth in profits. If current profit growth persists, even briefly, it becomes a viable proxy for near-term future profitability and, by extension, for expected returns.
The persistence turns out to be real. Using US data from July 1974 through December 2024, and international data from January 2005 through December 2024, the team demonstrates that moving from the bottom decile to the top decile of current profit growth is associated with a four-to-five-decile increase in profit growth one quarter into the future, declining to a one-decile increase three quarters out. The signal then turns negative, consistent with competitive mean reversion.
Two Signals, One Story
Where the paper deepens is in its treatment of price momentum. Prior research has debated whether price momentum is an independent phenomenon or simply a noisy proxy for earnings momentum. The Dimensional team takes a position: both are legitimate, partially overlapping signals, each with distinct practical properties.
"Profit growth provides a cleaner but less frequently updated signal about future profit growth," the team writes, "while price momentum provides a continuously updated but noisier signal." The two, therefore, complement each other in forecasting cross-sectional differences in expected profitability and returns.
The average monthly overlap between portfolios sorted on profit growth and portfolios sorted on price momentum is approximately 40%, leaving 60% of the information in each signal that is not captured by the other. In portfolio terms, this means diversifying across both dimensions adds genuine information, not redundancy.
The Crash Test
One of the most practically useful findings concerns the volatility of each premium. In large caps, the annualized standard deviation of the momentum premium is 15.4% versus 9.3% for profit growth. In small caps, 15.8% versus 7.6%. The gap is largely explained by momentum crashes. In 2009, the small-cap momentum premium fell approximately 99%. The small-cap profit growth premium fell roughly 17%. For practitioners, that is not a statistical footnote. It is the difference between a usable factor and an unbearable one.
Profit growth, because it is tied to fundamental earnings trends rather than cumulative price returns, does not accumulate the same reversal exposure. Factor-spanning regressions confirm the finding: the five Fama/French factors, combined with price momentum and short-term reversal, cannot fully explain the profit growth factor. Its alpha survives.
A Rational Framework for Transient Momentum
The paper also advances a valuation-based explanation for why momentum's predictive power decays so quickly. All proxies, including profit growth, are positively related to future profitability only over the next three to four quarters. After that, the coefficients turn negative. Competitive forces erode above-normal profitability. As the team notes, drawing on Vassalou and Apedjinou (2004), successful innovations are imitated, leading innovators to lose part of their competitive edge.
The implication is that momentum is not anomalous under rational asset pricing. It reflects genuine uncertainty about near-term cash flows, which resolves over six to twelve months. The premium compensates for that uncertainty.
Five Key Takeaways for Advisors and Investors
- Profit growth is a predictive factor in its own right. Current profit growth, measured as the year-on-year change in quarterly operating profits scaled by book equity, predicts future profits and returns independently of current profitability.
- Neither signal subsumes the other. Price momentum and profit growth contain overlapping but meaningfully distinct information. Using both improves expected return forecasts.
- Profit growth is a more stable premium. Because it is not vulnerable to momentum crashes, profit growth may be more practically implementable, particularly in small caps.
- The findings are global. Results hold across US, developed ex-US, and emerging markets, and are robust to different earnings reporting regimes.
- Momentum's short life makes theoretical sense. Both signals forecast returns only over the near term, which is consistent with competitive mean reversion in profitability under rational asset pricing.
Footnote:
1 Ahn, Byung Hyun, Tom Lord, Mia Huang, Namiko Saito, Stanley Black, and Savina Rizova. "Profit Growth and Expected Stock Returns." Dimensional Fund Advisors, October 2026. Available at SSRN: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=7549838
