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Multi-Factor Investing: Quality Stock / ETF

Personal Finance & Money Asked by SimpleThings on March 26, 2021

I am trying to build a multi-factor portfolio which includes the Quality factor. However, I am having problem finding out which of the ETFs (that I am considering) has higher profitability / quality premium, and thus it contains more "quality" stocks as well.

I read the book "Your Complete Guide to Factor-Based Investing" by Andrew L Berkin, Larry E Swedroe where it was mentioned that:

  1. Firms with high profitability measured by earnigns have high subsequent returns after controlling for book-to-market ratio and investment.
  2. Profitability has roughly same power as book-to-market ratio in predicting the cross-section of average returns.
  3. Profitabile firms tend to be growth firms with high cash flows
  4. Profitable firms generate significally higher returns than unprofitaable firms, despite having significantly higher valation ratios (e.g. price-to-book ratio)
  5. Controlling for profitability dramatically raises the performance of value strategies, especially among the largest, most liquid stocks. Controlling for book-to-market ratio improves the performance of profitability strategies.

So I was thinking how to use this information in order to recognize a quality company. So I digged out the following information for ETFs I am considering:

  1. Price/Earnings Ratio
  2. Price/Cashflow Ratio
  3. Price/Book Ratio
  4. Price/Sales Ratio

and stock style percentage:

  1. Large-Value
  2. Large-Blend
  3. Large-Growth

Now I am trying to understand how to use this metrics to find out an ETF with the highest quality premium. From the upper most points 1) & 4) I guess I should consider ETF which has Price/Earning and Price/Book ratios?
From the point 3) I guess I have to aim for an ETF that has big allocation in "Large-Growth" stocks.
I also think that Price/Cashflow Ratio might play a role as well?

Basically my quesiton boils down to what correlation the above metrics (ratios) need to have in order to be classified as a high quality ETF?

Sorry if my questions seem to be confusing, but I have begun getting into finances only recently and have a totally different background.

Thank you in advance!

One Answer

Index providers MSCI and S&P publish Quality factor indices and their methodologies.

Answered by Orange Coast- reinstate Monica on March 26, 2021

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