U.S. versus International Quality Stocks

Why should investors get compensated for holding high-quality stocks?

August 2024. Reading Time: 10 Minutes. Author: Nicolas Rabener.

SUMMARY

  • U.S. quality stocks have not outperformed or provided less risk than the market
  • International quality stocks have done so, but that has slowed down considerably in recent years
  • Quality is best used in combination with other factors rather than on its own

INTRODUCTION

The posts of social media influencers focused on personal finance are full of formulas that help investors select high-quality stocks, where low debt-over-equity, high return-on-equity, and high interest rate coverage ratios are some of the favorite metrics. Typically these posts are supplemented by leaning on heavy-weight investors like Warren Buffett who supposedly use the same ratios in their stock selection processes.

Unfortunately, it is not only retail but also professional investors who frequently fall for high-quality stocks. Everyone loves companies that feature low leverage and high profitability, but that leads to such stocks being perfectly priced, or overpriced.

We previously highlighted the lack of outperformance of quality stocks (read Quality versus Low Volatility ETFs and Oh, Quality, Where Art Thou?), but our research was focused on U.S. stocks.

In this research article, we will compare the performance of U.S. versus international quality stocks.

LONG-TERM FACTOR PERFORMANCE

First, we review the excess returns of the four factors from the Fama-French model using data for the U.S., Europe, Japan, and Emerging Markets from 1994 to 2024. We observe that all factors generated positive excess returns over the last 30 years, with size producing the lowest and value the highest returns on average.

Profitability, which is one of the core pillars of measuring quality, was strongest in the U.S. and lowest in Japan. However, the magnitude of excess returns was very low and this data includes micro-caps stocks and excludes transaction costs, i.e. the real excess returns would be close to zero or negative.