Quality investing : design of a quality definition from a practitioners' perspective

Abstract

This thesis highlights the complexity of Quality investing and the underlying large dispersion in Quality definitions. Indeed, there exists a fundamental difference in the perceptions of Quality between practitioners and academicians. Moreover, since academic studies appear to focus on Quality measures that have significant predictive power for stock returns, their Quality definitions tend to constantly outperform Quality definitions emanating from the industry. In an attempt to first reconcile practitioners and then impulse a convergence towards academic definitions, a survey has been carried out on a sample of practitioners with the aim of designing a generally accepted Quality definition made out of Quality measures supported by academic studies. Globally this Quality definition encompasses four dimensions – i.e. Profitability (captured by ROIC), Quality Earnings (captured by low accruals), Growth (captured by 3-year growth in cash flow over assets and 3-year growth in gross margin) and Safety (captured by low leverage).The Quality Minus Junk factor constructed on this new definition experiences, in fact, poor return performance in comparison to purely academic measures over a time period spanning from 2005 to 2015. This suggests that even when confronted to what exists in the academic side, practitioners stick to their comprehensive and pragmatic vision of Quality and do not improve the predictive power of their definition. In the light of these findings, one can expect the convergence towards a unique and effective Quality definition to be extremely complex so that funds which offer exposure to the quality factor should be cautious about their returns expectations and the way they market their strategy.