By Eric Dutram, DWS
Anyone starting a new diet knows that there is one factor to watch out for more than anything: quality. Quantity is definitely important as well, but you are more likely to make progress if you focus on unprocessed, natural foods.
While it can be extremely difficult to cut back on the snacks, leaving the junk food behind in a new diet regimen is often the only way to make a lasting improvement. So although a number of other factors can contribute, quality needs to be at the center of the process, no matter how tough it might be.
The same might be said about investing. But unlike nutrition, it can be a whole lot easier to build a quality investment portfolio than a quality-centric diet. To do this, investors have specific factors to help guide them. Think of them like the nutritional components of a stock. These factors help to explain various stocks’ risk and return profiles. And different equities can be blended to build a proper ‘diet’ or portfolio.
Quality in Investing
While quality in the food world might consist of labels such as organic, low-sodium, or no trans-fats, in the investing world the equivalent factors are things like profitability, earnings stability, financial leverage, and corporate governance.
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There are a number of ways to achieve quality in these key areas. Some of my personal favorites are focusing on companies with high readings for their return on equity (ROE), a figure which helps to demonstrate how shrewd a company is with investor capital; solid earnings growth, which can be an indicator of a nice financial trend; low market leverage, which gives managers options for the future; and a strong shareholder rights policy, ensuring that those with ownership get a say in how things are run.