Investors should be looking for quality stocks, right?

Posted by Robin Powell on March 31, 2016

“It’s far better to buy a wonderful company at a fair price,” Warren Buffett once said, “than a fair company at a wonderful price.”

The problem is that markets today are generally pretty efficient, and deciding whether a particular security is fairly priced is not straightforward, even for the likes of Buffett.

In theory, of course, high-quality companies should command a higher price. Firms like Apple or Google, for example, are expected to carry on being successful; logically, then, investors who hold those stocks will want to be properly compensated for giving them up.

It begs the question then, Can quality stand on its own as a factor driving higher returns? Or is price more important?

The question is addressed in a fascinating article by Ben Johnson, Director of Global ETF Research for Morningstar. Ben has one of the sharpest minds in the industry. A staunch advocate of low-cost, evidence-based investing, he was a contributor to our first documentary for Sensible Investing TV, Passive Investing: The Evidence, and it’s always worth listening to what he has to say.

As Ben explains, defining quality in the first place is a challenge in itself. Criteria used to define quality include measures of profitability, stability, growth and financial health; but different people use different measures and have different points of emphasis.

I’d urge you to read the article, but in a nutshell this is what he argues:

  • quality does not appear to work as a standalone factor, but
  • is “best thought of as an enhancer, an ingredient”, with the potential to “amplify the gains from value”; and
  • blending quality with value, momentum and other uncorrelated factors may help to smooth out the cyclicality associated with owning any single factor in isolation.

I’m not a factor wonk myself. You can spend ages investigating factors that will probably end up making little or no difference. As an investor you should be suspicious of complexity, and particularly of investment professionals who use it to justify charging you more.

That said, there’s now a welter of funds available that look to capture quality as part of a combination of factors, and there is a case for using them if you want to as part of a broader strategy.

Here’s Ben’s article:

The What, Why and How of Quality

Robin Powell

Robin is a journalist and campaigner for positive change in global investing. He runs Regis Media, a niche provider of content marketing for financial advice firms with an evidence-based investment philosophy. He also works as a consultant to other disruptive firms in the investing sector.


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