Abstract
Investments in Brazil are increasingly allocated to the stock market, at the expense of more conservative investments. Would finding higher-quality assets allow investors to increase their risk-return ratio? We analyze quality with several metrics, including the quality-minus-junk (QMJ) factor for Brazil. We find that quality companies are valued more by investors, with a higher price-to-book ratio. A portfolio of shares of higher quality shows a significant positive return over the period analyzed, adjusted for several risk factors. The sample members classified as quality companies remained within this classification over time.
Highlights
An extensive literature on risk factors explains returns on assets
These filters follow those used by the Center for Research in Financial Economics (NEFIN) at the University of São Paulo (USP) in its studies related to risk factors
We describe each variable presented in Equation (1) below: 1. Profitability: It combines gross profit on total assets (GPOA), return on equity (ROE), return on assets (ROA), cash flow on total assets (CFOA), gross margin (GMAR), and accruals: Profitability = z(zGPOA + zROE + zROA + zCFOA + zGMAR + zACC)
Summary
An extensive literature on risk factors explains returns on assets. One of the most famous asset pricing models, created by Fama and French (1993), has undergone several updates over the years. The intuition behind creating this factor is that higher-quality assets, all else being constant, should be more expensive than low-quality assets, eliminating higher risk-adjusted returns for a portfolio long on high-quality assets and short on assets with low-quality characteristics. Asness et al (2019) connect these disparate ideas, presenting a common characteristic among them: the quality of the company. This factor can explain a positive relationship between prices and quality.
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