The quality through still overshadowed by growth, low volatility, and value, is sort of all the rage these days and with good reason. Plenty of ETFs help investors join the quality party, including the FlexShares US Quality Large Cap Index Fund (CBOE: QLC).
QLC selects and weights companies based on management efficiency, profitability, and cash flow to determine quality, according to FlexShares. Management efficiency is a quantitative evaluation of a firm’s deployment of capital and its financing decision. Profitability scores help weed out firms with wider margins, which may be better positioned to grow. Lastly, cash flow signals the liquidity level of a company. Those with higher cash flows may be better situated to take advantage of potential opportunities or enjoy a financial cushion in downturns.
QLC skirts value traps by including momentum characteristics, which will be determined through a stock’s price history to capture a picture of the recent performance and by using analysts analyst outlooks to get a sense of future sentiment regarding a company. About half of QLC’s holdings are classified as value stocks.
Counting on QLC
Quality should not be conflated with low volatility, but there are times when quality stocks display low volatility traits. That was the case during the fourth quarter of last year’s market swoon, indicating that the quality factor can provide some protection during times of elevated market stress.
Historical data indicate the quality factor is a winner over long holdings periods. In the early stages of bull markets, lower-quality companies see their shares soar. However, as the bull matures, investors often exhibit a preference for higher quality fare with more compelling valuations.
The quality factor is a point of emphasis for a growing number of strategic beta ETFs. Though there has been debate surrounding defining quality as it pertains to factor-based investing, quality companies and dividend-paying stocks often go hand-in-hand because those dividends are seen as signs of stable earnings and thoughtful management.
“The quality factor originally was designed as a tool to gain confidence in the financial strength of dividend-paying equities, but investors have steadily evolved how they use it in their portfolios,” said FlexShares. “Instead of looking at dividend-paying equities as a means to meet income needs, quality dividend payers can also be looked at as a means to grow assets through their core investments.”
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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.