Overview
Quality is hard to define, and the word does not have a solid definition within the equity investing world. At a basic level, quality companies are well designed and exhibit desirable qualities. This is contrast to the a value company, which could be a low qaulity company that is selling at a discount.
When discussing quality of an equity investment, quality is typically meant to refer to the company's financials or market position, rather than an attribute of its products, although many investors will include product considerations in their assessment of quality.
“It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”
-Warren Buffett
Quality Factors
The primary thing that a quality investor looks for is that the company being invested in is a great company. Whereas a value investor might invest in bad companies as long as the price is right, and a growth investor might invest in a poorly run company with growth potential, the quality investor focuses mostly on the quality of the company and its management, and only then considers price and growth.
The following factors represent a sample of the types of qualities that a quality investor looks for.
- Earnings Stability
- the earnings do not exhibit large standard deviations
- Resistant to Economic Downturns
- Earnings readily translates to free cash flow
- Diverse Customer Base
- High Returns on (Invested) Capital
- Strong Competitive Advantage
- Favorable Industry Position (see
Porter)
- Market Leader in their Industry
- Cost Advantages
- Network Effects
- Pricing Power
- Favorable Industry Position (see
Porter)
- Strong and Experienced Management Team