What is it?
The Fama-French 5-Factor Model is an attempt to explain what drives stock returns. Eugene Fama and Kenneth French first introduced the 3-factor version in the 1990s — adding size and value to the basic market factor — and then expanded it in 2015 by adding two more: profitability and investment.
So now we’ve got:
- Market risk (beta),
- Size (small beats big),
- Value (cheap beats expensive),
- Profitability (more profitable beats less), and
- Investment (low reinvestment beats high reinvestment).
It’s a neat package, statistically tested across decades of data, and taught in most finance programs today. You can think of it like a toolset — not just for explaining returns, but for building portfolios with intentional tilts.
Why it matters
If you’re serious about investing — especially value investing — this model matters. A lot.
It gives you a language to describe what you’re actually doing. You might think you’re picking great companies at good prices. But maybe, under the hood, you’re just running a portfolio tilted toward high operating profitability and low valuation multiples — exactly what this model measures.
It also gives you some defense. When you underperform for a year or two (which you will), you can say: “Hey, I’m not failing. My factor tilts are just out of favor right now.” It doesn’t make the pain go away, but it helps you keep the faith.
How do you use it?
You don’t need to run regressions in R to benefit from this model.
At its simplest, you can screen for stocks with:
- Low price-to-book or price-to-earnings (value),
- Strong return on equity or gross profitability (profitability),
- Low asset growth or capital expenditures as a % of assets (investment).
You can also look at ETFs that target these factors — some track Fama-French-style indexes, others build on them (like AQR or Alpha Architect funds).
If you manage your own portfolio, you can use the 5 factors as a mental checklist:
“Is this company cheap? Profitable? Growing responsibly?”
If two out of three are ‘yes’, you’re probably in the right zone.
Does it work?
Yes — on paper. And often in real life, too.
Historically, the value, size, and profitability factors have all earned a premium over the market. The investment factor is more mixed, but adds something in certain time periods. The model explains a large chunk of the variation in stock returns over time — much more than CAPM or random dart throws.
But let’s be honest. It’s not magic.
Over the last decade, value has lagged — sometimes badly — and the size factor hasn’t shown much either. Some argue it’s just cyclical, others say the market has evolved. Tech and intangible assets, for example, break a lot of the model’s assumptions. A company like Google looks expensive on book value, but it’s a cash machine.
Also, the data keeps shifting subtly. What Fama and French called “robust profitability” in 2015 is slightly different from what quant shops call it today. And if everyone piles into the same factor portfolios, those factors stop being anomalies — they become crowded trades.
In short: the 5-Factor Model works… but not in every period, not in every sector, and not without judgment.
The Fama-French 5-Factor Model is one of the best tools we’ve got for thinking about long-term stock returns. It gives structure to value investing without turning it into pure guesswork.
But like any model, it simplifies reality. It doesn’t capture narrative, management skill, capital allocation nuance, or changing investor behavior. It’s not supposed to.
Use it like a compass, not a GPS. It can point you in the right direction — but you still have to walk the terrain yourself.