Factor Exposure Analysis 113: Profitability vs Leverage Factors
What quality and growth factors should investors be using in a factor exposure analysis?
March 2025. Reading Time: 10 Minutes. Author: Nicolas Rabener.
SUMMARY
- Funds’ factor betas change when using multiple quality and growth factors
- It does not necessarily improve the explanatory power of the regression analysis
- Yet, it is useful to have more factors as it makes the analysis clearer
INTRODUCTION
In our latest article, Factor Exposure Analysis 112: Quality vs Growth Factors, we emphasized that selecting independent variables for a factor exposure analysis is inherently subjective, given the vast array of potential equity and macro factors. Our findings showed that quality metrics such as leverage and profitability have low correlations, suggesting the need for multiple quality factors, whereas growth metrics like sales and earnings growth are highly correlated.
In this research article, we explore the impact of using different quality and growth factors when analyzing smart beta ETFs.
QUALITY & GROWTH FACTOR PERFORMANCE
We examine two key quality metrics – leverage (debt-to-equity) and profitability (return-on-equity) – along with growth, defined as a combination of sales-per-share and earnings-per-share growth.
Constructing a beta-neutral portfolio using the top and bottom 30% of U.S. stocks ranked by these metrics shows no excess returns for leverage or growth over the past 20 years. While profitability has generated positive returns, the majority of these gains have occurred in the last three years.
