# Quality and Profitability Factors > The quality factor favours profitable, stable, conservatively financed companies. Learn how quality is measured, the evidence and how it pairs with value. Source: https://learn.tradelabsai.com/research/quality-factor/ Track: Research and Backtesting · Level: Advanced · Updated: 2026-10-03 Publisher: TradeLabs AI (https://tradelabsai.com). Education, not financial advice. Cite as: TradeLabs Learn, "Quality and Profitability Factors", https://learn.tradelabsai.com/research/quality-factor/ The quality factor captures the tendency of high quality companies, those that are profitable, stable, growing steadily and conservatively financed, to deliver better risk adjusted returns than low quality companies. Unlike value, which focuses on price, quality focuses on the business itself. Quality has been one of the more consistent factors in recent decades and tends to hold up well during market downturns, making it popular with both quantitative and fundamental investors. ## How quality is measured There is no single definition. Common components: | Dimension | Example measures | Lesson | |---|---|---| | Profitability | Gross profit to assets, ROE, ROIC, margins | [ROE, ROA and ROIC](https://learn.tradelabsai.com/fundamentals/roe-roa-and-roic/) | | Earnings stability | Low variability of earnings over time | | | Balance sheet strength | Low leverage, high interest coverage | [Operating and Financial Leverage](https://learn.tradelabsai.com/fundamentals/operating-and-financial-leverage/) | | Earnings quality | Low accruals, cash backed earnings | [Earnings Quality and Cash Conversion](https://learn.tradelabsai.com/fundamentals/earnings-quality/) | | Growth | Steady growth in profits | | | Payout and investment | Shareholder returns; conservative investment | [Capital Allocation and Management](https://learn.tradelabsai.com/fundamentals/capital-allocation/) | ## The evidence - **Robert Novy Marx (2013)** found that gross profitability (gross profit divided by assets) predicted returns as strongly as book to market, and that profitable firms outperformed unprofitable ones. - **Fama and French (2015)** added a profitability factor (RMW, robust minus weak) and an investment factor to their five factor model. - **Asness, Frazzini and Pedersen (2019),** in "Quality Minus Junk", built a broad quality measure and found that high quality stocks earned higher risk adjusted returns across many countries. **Example: Quality in a downturn** During the 2008 crisis and the early 2020 COVID selloff, portfolios long high quality stocks and short low quality ("junk") stocks gained or held up much better than the market, as investors fled to financially strong companies. This "flight to quality" behaviour makes the quality factor a useful diversifier for portfolios exposed to market and value risk. In speculative rallies, such as parts of 2020 and early 2021, junk stocks rallied hard and quality lagged. See [The COVID-19 Crash](https://learn.tradelabsai.com/history/the-covid-19-crash/). ## Why might quality work? | Explanation | Idea | |---|---| | Behavioural | Investors underappreciate boring, steady profitability and overpay for exciting speculative stocks | | Lottery preferences | Investors overpay for unprofitable stocks with small chances of huge gains | | Durable advantages | Profitable firms often have moats that persist. See [Competitive Advantage and Moats](https://learn.tradelabsai.com/fundamentals/competitive-advantage-and-moats/) | ## Quality and value: a strong pair Cheap stocks are often cheap because they are low quality; expensive stocks are often high quality. Combining the two, "quality at a reasonable price", helps avoid value traps and overpriced quality. Benjamin Graham and Warren Buffett both emphasised buying good businesses at sensible prices. Quantitative research has found that value and quality combine well because they are negatively correlated. See [Value Factor](https://learn.tradelabsai.com/research/value-factor/) and [Combining Signals](https://learn.tradelabsai.com/research/combining-signals/). ## Quality and low volatility High quality stocks tend to be less volatile, so the quality and low volatility factors overlap. Some research argues part of the low volatility effect is explained by profitability. See [Low Volatility and Defensive Factors](https://learn.tradelabsai.com/research/low-volatility-factor/). ## Risks - **Valuation:** quality stocks can become expensive when popular. - **Definition sensitivity:** results vary with the measures used. - **Speculative rallies** where junk outperforms. - **Crowding** in popular quality ETFs. See [Factor Timing, Crowding and Crashes](https://learn.tradelabsai.com/research/factor-crowding/). ## Building a simple quality score A practical quality score might average the cross sectional ranks of gross profitability, return on equity, low leverage and low accruals. Stocks in the top third form the quality portfolio. Using several measures reduces dependence on any one accounting figure and makes the score harder to game. See [Combining Signals](https://learn.tradelabsai.com/research/combining-signals/). ## Frequently asked questions ### What is the quality factor? A factor that favours companies with high profitability, stable earnings, strong balance sheets and good earnings quality. ### Does the quality factor work in downturns? Historically it has tended to hold up well in market selloffs, as investors move toward financially strong companies. ### Why combine quality with value? Because cheap stocks are often low quality, and combining the two helps avoid value traps while not overpaying for quality. Next, learn about the small company effect in [Size Factor](https://learn.tradelabsai.com/research/size-factor/). ## Continue learning - Next lesson: [Size Factor](https://learn.tradelabsai.com/research/size-factor/) - Previous lesson: [Momentum Factor](https://learn.tradelabsai.com/research/momentum-factor/) - Related: [Momentum Factor](https://learn.tradelabsai.com/research/momentum-factor/): The momentum factor buys recent winners and sells recent losers. Learn how it is built, the evidence across markets, momentum crashes and how to manage them. - Related: [ROE, ROA and ROIC](https://learn.tradelabsai.com/fundamentals/roe-roa-and-roic/): ROE, ROA and ROIC show how efficiently a company turns capital into profit. Learn the formulas, the DuPont breakdown, why ROIC versus WACC matters and the pitfalls. - Related: [Earnings Quality and Cash Conversion](https://learn.tradelabsai.com/fundamentals/earnings-quality/): Earnings quality asks whether reported profits are real, repeatable and backed by cash. Learn accruals, warning signs, the Beneish model and famous frauds. - Related: [Value Factor](https://learn.tradelabsai.com/research/value-factor/): The value factor buys cheap stocks and avoids expensive ones using ratios like book to market. Learn the evidence, the long drawdown and how to build it. - Related: [Low Volatility and Defensive Factors](https://learn.tradelabsai.com/research/low-volatility-factor/): The low volatility anomaly is the finding that less volatile stocks have delivered better risk adjusted returns. Learn the evidence, explanations and its risks. - Related: [Competitive Advantage and Moats](https://learn.tradelabsai.com/fundamentals/competitive-advantage-and-moats/): An economic moat is a durable advantage that protects a company's profits from rivals. Learn the main sources, how to spot them in the numbers and how they erode.