Asness et al. (2019): Quality Minus Junk — The Complete Quality Factor

#The Paper at a Glance

Title: Quality minus junk

Authors: Clifford S. Asness, Andrea Frazzini, and Lasse Heje Pedersen (AQR Capital Management)

Published: Review of Accounting Studies, 2019

DOI: 10.1007/s11142-018-9470-2

This paper unified scattered research on "quality" into a single, comprehensive framework. Rather than arguing about which profitability measure to use, Asness and colleagues defined quality along four dimensions and showed that the combined signal is more powerful than any individual component.

#The Four Pillars of Quality

1. Profitability

High-quality companies earn more per dollar of assets: - Gross profitability (GP/Assets) - Return on equity (ROE) - Return on assets (ROA) - Cash flow over assets

2. Growth

Quality companies are growing, not shrinking: - 5-year growth in profitability measures - Growth signals sustained competitive advantage

3. Safety

Quality companies are less likely to blow up: - Low leverage (debt/assets) - Low earnings volatility - Low beta (market sensitivity) - Low bankruptcy risk (Altman Z-score)

4. Payout

Quality companies return cash to shareholders: - High dividend + buyback yield - Low net issuance - Signals management discipline

#What the Paper Found

Global Quality Premium

The quality premium is statistically significant everywhere, and the t-statistics far exceed the Harvey et al. (2016) threshold of 3.0.

Quality Prices vs. Quality Returns

Here's the puzzle: quality stocks trade at higher valuations. The market recognizes quality and pays more for it. So how can quality stocks still outperform?

Asness et al. showed that the market doesn't pay enough for quality. Investors underestimate the persistence of quality characteristics. A company that's highly profitable today is likely to remain highly profitable for years—but the stock price doesn't fully reflect this.

Crash Protection

One of QMJ's most valuable features is downside protection:

Quality outperforms most dramatically during market crashes. When investors panic, they sell everything—but quality companies have the balance sheets and earnings power to weather storms.

#Why Investors Underprice Quality

1. Lottery Preferences

Investors are drawn to speculative "junk" stocks with exciting stories and upside potential. They overpay for lottery tickets and ignore boring quality.

2. Tracking Error Aversion

Professional money managers fear underperforming their benchmark. Quality stocks can lag during speculative rallies, creating career risk.

3. Limited Attention

It takes work to assess all four quality dimensions. Most investors focus on one or two metrics, missing the full picture.

#Quality vs. Other Factors

Quality's combination of strong returns AND crash protection makes it arguably the most attractive factor for long-term investors.

#How This Applies to Our Rankings

Our ranking system draws heavily from QMJ's quality framework:

• Profitability (30%) captures the first and most important pillar
• Investment (10%) overlaps with growth and capital discipline
• Low Volatility (10%) captures elements of safety
• Momentum (25%) is negatively correlated with quality, providing diversification

While we don't replicate QMJ exactly, our multi-factor model captures the spirit of "buy quality, avoid junk" across multiple dimensions.

See top-quality stocks →

#Academic Source

Asness, C. S., Frazzini, A., & Pedersen, L. H. (2019). "Quality minus junk." Review of Accounting Studies, 24(1), 34-112.