Investing in high-quality stocks can be a great strategy to obtain superior returns over the long term. Few investors would disagree with that statement. However, implementation is the key part. Quality can be defined in multiple ways, and finding high-quality stocks is much easier said than done.
Nevertheless, business quality can also be measured through financial indicators and profitability ratios, and superior profitability over the long term is many times a sign of superior fundamental quality too.
Success attracts competitive pressure in the business world. When a company is doing well in a particular market, chances are that the competition will try to intensify the pressure to steal some of those profits. Only the companies with superior fundamental quality and competitive strengths can sustain above-average profitability levels over long periods of time.
The following screener looks for companies with superior profitability across the board by relying on metrics like operating profit margins, return on equity, and return on investment. The main idea is focusing on different kinds of profitability metrics in order to find companies with consistently superior quality across different indicators.
Strategy Design
To begin with, the screener considers only companies with a market capitalization value above $250 million. This requirement has a negative impact on returns because many times the small companies are the ones that deliver the bigger gains. However, it makes sense to guarantee a minimum size for inclusion in the screen due to risk and liquidity considerations.
After that, the screener measures companies based on 3 different profitability ratios: operating profit margin, return on equity, and return on investment. The average value for the three ratios needs to be above zero over the past five years and also above the industry average.
Operating profit margins measure profits at the operating level as a percentage of
