Quality Minus Junk

Abstract

We define a quality security as one that has characteristics that, all-else-equal, an investor should be willing to pay a higher price for: stocks that are safe, profitable, growing, and well managed. High-quality stocks do have higher prices on average, but not by a very large margin. Perhaps because of this puzzlingly modest impact of quality on price, high-quality stocks have high risk-adjusted returns. Indeed, a quality-minus-junk (QMJ) factor that goes long high-quality stocks and shorts low-quality stocks earns significant risk-adjusted returns in the U.S. and globally across 24 countries. The price of quality varies over time, reaching a low during the internet bubble, and a low price of quality predicts a high future return of QMJ. Analysts’ price targets suggest that the required return of quality stock is low despite the high realized return.

Keywords: Quality Investing, Quality Minus Junk, QMJ

JEL Classification: G10, G11, G12