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Quality minus junk

Author

Listed:
  • Clifford S. Asness

    (AQR Capital Management)

  • Andrea Frazzini

    (AQR Capital Management
    NYU)

  • Lasse Heje Pedersen

    (AQR Capital Management
    NYU
    Copenhagen Business School
    CEPR)

Abstract

We define quality as characteristics that investors should be willing to pay a higher price for. Theoretically, we provide a tractable valuation model that shows how stock prices should increase in their quality characteristics: profitability, growth, and safety. Empirically, we find that high-quality stocks do have higher prices on average but not by a large margin. Perhaps because of this puzzlingly modest impact of quality on price, high-quality stocks have high risk-adjusted returns. Indeed, a quality-minus-junk (QMJ) factor that goes long high-quality stocks and shorts low-quality stocks earns significant risk-adjusted returns in the United States and across 24 countries. The price of quality varies over time, reaching a low during the internet bubble, and a low price of quality predicts a high future return of QMJ. Analysts’ price targets and earnings forecasts imply systematic quality-related errors in return and earnings expectations.

Suggested Citation

  • Clifford S. Asness & Andrea Frazzini & Lasse Heje Pedersen, 2019. "Quality minus junk," Review of Accounting Studies, Springer, vol. 24(1), pages 34-112, March.
    • Handle: RePEc:spr:reaccs:v:24:y:2019:i:1:d:10.1007_s11142-018-9470-2
    DOI: 10.1007/s11142-018-9470-2
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    References listed on IDEAS

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    More about this item

    Keywords

    Quality; Valuation; Accounting variables; Profitability; Growth; Safety; Analyst forecasts;
    All these keywords.

    JEL classification:

    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G4 - Financial Economics - - Behavioral Finance
    • M4 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting

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