Understanding the quality phenomenon; what it is and why it exists

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Quality, Top Investors and Morevia Mebane Faber

 

I linked to four great recent research pieces out of NT, and take my word for it – just download them or print them out and read when you have a chance.  One chart then downloads:

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Defining Quality

Perspective

Illuminating Returns of Elite Investors

Five Year Outlook

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Via The Idea Farm

What is Quality?

Although the concept of quality has been deeply entrenched in other asset classes for decades, how this idea relates to stock selection has received considerable attention over the last few years. In this paper we explore the theme of equity quality and attempt to answer several important questions:

  • How do we define quality? Are all definitions of quality equal? If not, what constitutes an “optimal” definition of quality?
  • Is quality a reliable predictor of equity returns? In other words, is it a compensated risk factor? If so, why? Is there a rational explanation for why investors should be rewarded for holding high-quality stocks?
  • Are returns to quality consistent or are they highly period specific? Is there a quality “cycle” and, if so, can we rotate in and out of quality to achieve better returns?
  • Should index investors be concerned about quality?
  • Is quality related to the low volatility phenomenon?

Defining Quality

Unlike other equity factors such as value or size, there is no generally agreed upon definition of quality. Although the pervasive, intuitive notion is that HQ companies should have better overall performance than low-quality companies, their differentiating characteristics are hotly debated.

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