A Better Way To Seek Out Quality Stocks

A Better Way To Seek Out Quality Stocks

In times of volatility, investors lean more towards stocks that have steady earnings and solid balance sheets, and recent research from Vanguard displays a new way to get a better performance out of the quality factor, reports an article in Institutional Investor. Portfolios with quality stocks can bump their returns up .60% when investors add intangible assets to their definition of quality, the study found.

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A company’s intangible assets range from the investment they put into research and development, intellectual property, expenses for software and technology, as well as costs for branding and employee well-being. Those aspects of a quality company can sometimes be harder to suss out than typical factors like growth, value, and momentum, and as such haven’t been used as much when creating a portfolio that weights toward the quality factor. But “intangible capital has become increasingly more crucial to a nation’s economic development,” wrote the study’s authors: Mattia Bacciardi, Haifeng Wang, Jishan Mei, and Miao Yang. However, intangible assets are unique to each company, and therefore give that company an edge over its competitors, according to the article.

The Vanguard researchers took return data from Russell 3000 index companies and built two portfolios: one which didn’t take intangibles into account, and one that weighted towards companies with more intangible assets. The former returned 13.4% annually over 30 years from 1992 to 2022, while the latter gained 14% over the same period. In addition, the intangible asset portfolio garnered a 73% Sharpe ratio compared to 67% from the benchmark portfolio, and had also had a lower maximum drawdown of -10% compared to the former’s -13%. The results led the researchers to write that including the quality factor in the portfolio “exhibits a better risk-return profile and a more desirable factor exposure,” the article quotes. The study also displayed that the intangible asset premium showed up across a range of industries and various time periods that were looked at.

While intangible assets had been used to improve the value factor—arguably with not much success, given value’s underperformance for so many years—it’s now being looked at as “a possible new addition to the quality factor,” the researchers wrote.