- 1Quality stocks have high and stable profitability metrics
- 2Key measures: ROE, gross margin, operating margin, earnings consistency
- 3The quality/profitability factor has earned a significant premium historically
- 4Quality stocks tend to hold up better during market downturns
- 5Novy-Marx (2013) showed gross profitability is a powerful predictor of returns
#What Is a Quality Stock?
"Quality" in investing means companies that are fundamentally excellent — highly profitable, well-managed, with durable competitive advantages. These businesses:
- Generate high returns on invested capital
- Maintain wide profit margins
- Produce consistent, predictable earnings
- Have clean balance sheets with manageable debt
- Convert earnings into actual free cash flow
Quality investing became a recognized factor after Robert Novy-Marx published his influential 2013 paper showing that gross profitability (gross profit ÷ total assets) strongly predicts stock returns.
Read our summary: Gross Profitability Factor →
#How We Measure Quality
Our Profitability factor score uses multiple metrics to capture different dimensions of quality:
Gross Margin
Revenue minus cost of goods sold, divided by revenue. Measures pricing power and competitive advantage.
Operating Margin
Operating income ÷ revenue. Shows how efficiently management runs the core business.
Return on Equity (ROE)
Net income ÷ shareholders' equity. Measures how effectively the company uses shareholder capital.
Return on Invested Capital (ROIC)
Operating profit after tax ÷ (equity + debt - cash). The most comprehensive profitability metric.
#Quality vs. Value: Surprisingly Complementary
You might think quality and value are opposites — quality stocks command premium valuations. But academically, these factors have negative correlation, meaning they complement each other:
| Strategy | Returns | Risk | Combined |
|---|---|---|---|
| Value Only | High | High | — |
| Quality Only | Moderate-High | Low | — |
| Value + Quality | Highest | Moderate | Best risk-adjusted returns |
Warren Buffett's approach is essentially quality + value: buying wonderful companies at fair prices.
#Quality Characteristics by Sector
| Sector | Quality Leaders Tend to Have |
|---|---|
| Technology | Software with 70%+ gross margins |
| Healthcare | Patented drugs, recurring revenue |
| Consumer Staples | Iconic brands, pricing power |
| Financials | High ROE, low credit losses |
| Industrials | Niche markets, switching costs |
#Quality During Market Downturns
One of quality's biggest advantages: downside protection. During bear markets, quality stocks typically fall less because:
- Strong balance sheets reduce bankruptcy risk
- High margins provide a profit buffer
- Cash generation continues even in recessions
- Investors flee to quality during uncertainty
#View Our Quality Rankings
Sort by Profitability factor to find the market's highest-quality businesses.
Last updated: February 6, 2026