The Profit Factor

Fundamentals of Market Investing by Adam J. McKee

Also referred to as the quality factor, the profit factor involves picking stocks based on the quality and consistency of earnings and balance sheet strength.  Quality stocks are often considered more defensive in nature and have tended to perform best at the peak of an economic cycle or at the beginning of an economic slowdown.  The key to isolating this factor seems to be the difference between profitability and earnings.  There is the difficulty in separating profitability from growth since profitability and growth tend to be intricately related.

This relationship tends to provide a negative correlation with value, so there is the potential for quality stock exposure to provide a hedge for value exposure.  The quality factor is difficult for the small retail investor to buy directly via mutual funds, but several ETF options are available.  Individual fund managers may hold that free cash flow is king, and may invest with a profit factor strategy without calling it such.

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Last Updated: 6/25/2018

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