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April 2024 · 5 min read

Building a quality strategy with Xplore Stocks


This is our sixth article showing how to use Xplore Stocks to build your own investment strategy and this article will focus on a quality factor as opposed to a value strategy. Descriptions of all the metrics we surface to our users can be found Xplore glossary.

As we have discussed in a previous quality post, over the last decade from 2010-2020 the quality factor has performed reasonably and offered some diversification. Naturally it struggled to keep pace with the S+P 500, which was driven by a strong quantitative easing tailwind and a tech/growth trend. However, given the pullback in the markets and the new inflationary environment, various market commentators have mentioned that quality stocks, with strong balance sheets and robust earnings could do well going forward. Investment bank JP Morgan equity research team have mentioned this

Our outlook is unchanged across factors: We continue to see generally attractive prospects for a wide range of factors; equity value remains especially attractive, as do equity quality and equity momentum in U.S. markets

Likewise Blackrock Andrew Ang has again been emphasising that quality, in addition to value, may be nice additions to your portfolio.

BlackRock’s Fundamental Equities team recently discussed why now may be the time to stock up on quality. Quality stocks may provide resilience when markets are volatile, or the business cycle is maturing. Like value, quality stocks are also cheap relative to the broad market.

Let's walk through a full example of how to use Xplore Stock to build your very own quality investing strategy.

Choosing our universe and sectors

Every user has a choice as to what stocks and sectors to include at the start of their strategy research. These can be personalized to your investing thesis however the results of your strategy, in terms of risk and return and also robustness, will depend on this choice. If you narrow down your choices too much and then apply filters that are a bit too strict, you may end up with no strategy as no stocks satisfied all your criteria. For initial research, we prefer to choose all market caps and all sectors and Xplore defaults to this for our users.

What universe do we want to use for the construction of our quality strategy. We default to using all market caps and all sectors.
Which quality factors will we pick

Under the Filters section, users can click "Add Factors" to start accessing all our available factors. Given we are designing a specific quality strategy we are going to focus on only the quality group for this article and ignore the other categories such as value and technicals.

The full list of quality metrics we can choose from for our quality strategy.

We want to design a generic quality strategy and so for that purpose, we keep our choices of filters simple. This will hopefully ensure that we are able to generate a portfolio for our strategy (i.e that stocks can pass all these filters) every day back through our backtest. Percentiles are a nice, flexible way to use filters. If you want to apply a filtering so you only incorporate the top half of all stocks for that filter, you can simply choose greater than and then tick the percentile box. For our strategy we choose:

  • Operating cash flow ratio for all stocks in top half, greater than the 50th percentile
  • Return on equity for all stocks in the top half
  • Altman z-score > 3. This measures the risk of bankruptcy with a score of 3 or above indicating a solid company and a score close to 0 indicating some bankruptcy risk for the company
We can choose up to five metrics but we choose three for this quality strategy.
How do we want to sort our stocks

Once our strategy has been designed with all filters in place, it is time for sorting your stocks and no strategy can be completed without at least one sort chosen. Some classic sort factors we like to apply are momentum, volatility and liquidity and we used these in the construction of our value strategy. This time we wanted to highlight some other sort factors and so we chose

  • Gross margin defaults to sort by the HIGHEST value, stocks with the highest gross margin are to be included in your portfolio
  • Dividend yield defaults to sort by the HIGHEST value, stocks with the highest dividend yields are to be included in your portfolio
How do we want to rank our final list of stocks. We choose Gross Margin and Dividend Yield in place of any technical metrics.
Strategy analysis tab and results

After you Save your strategy and click Run Analysis you will automatically be taken to the Analysis page, which contains the headline results of your strategy and compares it to the S&P 500 benchmark. For a background on most of these metrics shown in under the backtest overview tab, users can check out these posts. While you are looking at and analyzing the analysis results, a tearsheet will also be running in the background. You will be notified when the tearsheet pdf is ready, which is also downloadable.

Analysis headline results for your strategy showing all your return, risk and drawdown metrics.
Analyzing your strategy tearsheet

Xplore Stocks also produces a tearsheet for every user for their own personal investing strategy. It covers a range of output to help users make their decision whether to invest using the strategy or go back and change some parameters and try again. It covers everything from overall risk and return results, to monthly and yearly performance, all the way to some sector breakdown at the end.

Tearsheet output for your first quality strategy.

In addition to headline results, we also show you more granular data that will describe any seasonality in your investment strategy and also its performance broken down into yearly returns.

Breakdown of your strategy showing its seasonal monthly returns and also the returns per year.

We hope you have enjoyed this article outlining how to use Xplore Stocks to create your first quality strategy.


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