The Value-Creation Pricing Factor

The description of returns associated with investment improves when substituting value in the Fama-French five-factor model with value-creation to market equity. Additionally, the description of returns associated with sorting onbothinvestment and profitability improves as well. Value-creation is measured by subtracting capital charges from operating income. Sorting stocks on value-creation-to-market produces a pricing anomaly in the US stock markets over the years 1963 to 2018. With an annualized risk premium of 6.29%, stocks with low market equity relative to value-creation, labeledas “cheap” stocks, outperform “expensive” stocks by a magnitude of 7.45 standard errors.