Why quality investing outshines value over the long term

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Subscribe to enjoy similar stories. Investing with a focus on the quality factor involves identifying companies that demonstrate strong financial health, sustainable competitive advantages, and consistent earnings growth. Quality and value are two of the oldest and most widely recognised factors in investing.

The quality factor, in particular, has historically performed well in the Indian stock market, benefiting from the country's unique economic conditions and market structure. Here's why quality as a factor tends to deliver reasonable returns: India’s stock market often experiences higher volatility compared to developed markets. Quality companies with strong balance sheets tend to outperform during periods of volatility; for example, during the covid period in Q1 of 2020, sectors such as healthcare, IT and FMCG, known for quality companies, handsomely outperformed the market, and the alpha in the three-month period was in the 5-20% range.

The volatility of these sectors was also much lower than that of the market. Quality stocks with strong fundamentals provide stability and consistently compounding returns over the long term. During speculative stages in the market, different sectors attract market attention for their potential.

However, only a handful of companies can deliver, making investors return to quality. The infrastructure sector in 2007, PSUs in 2014, and NBFCs in 2018 were all followed by prolonged periods of heartburn. Quality companies almost always deliver reasonable returns after these irrationally exuberant phases.