Ozkan Ozkaynak
September 21, 2023
This research explores the concept of Quality Investing in U.S. large capitalisation stocks, focusing on generating abnormal returns. By utilising fundamental metrics related to Profitability, Growth, and Safety, a quality score is calculated to construct portfolios of high-quality stocks. The study defines quality across three dimensions: Profitability, Growth, and Safety, and evaluates the effectiveness of various investing metrics and ratios within these dimensions. The research process involves creating 24 portfolios based on the defined quality criteria, with portfolio constituents recalculated annually. The performance of these portfolios is compared to the S&P 100 index, a benchmark for large capitalisation stocks. The study emphasises the importance of metrics like Return on Equity (ROE), Operating Income Growth, and Cash Flow to Debt ratios in constructing high-quality portfolios. The results highlight that all quality-defined portfolios consistently outperform the benchmark index, showing higher risk-adjusted returns and Sharpe Ratios. Notably, the portfolio defined using a combination of ROE, operating profit growth, and cash flow to debt ratio demonstrates particularly successful results, surpassing other portfolios and the broader market. In conclusion, the research findings indicate that focusing on quality, specifically through profitability, growth, and safety metrics, can lead to statistically significant annual returns (alpha) of 5.88%. This study is valuable for investors interested in long-term investments in U.S. large capitalisation stocks, offering insights into utilising quantitative analysis of fundamental ratios to achieve outperformance.
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The Little Book of Valuation by Aswath Damodaran is a concise guide aimed at investors who want to sharpen their skills in valuing companies and picking stocks. Damodaran emphasizes how to approach valuation from a disciplined, data-driven perspective, steering away from common misconceptions.
Here are the key takeaways from the book:
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Effective Valuation Tools: The book breaks down various methods of valuation, such as discounted cash flow (DCF) analysis and relative valuation. It helps readers understand when to use specific techniques and how to apply them to assess a company's true worth.
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Asset-Debt-Equity Dynamics: The relationship between a company’s assets, liabilities, and equity is critical to understanding its financial health. Damodaran discusses how these factors interact to influence the overall value of the business.
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Market Considerations: Valuation is not static—market conditions, economic cycles, and investor sentiment can impact a company's value. The book teaches how to remain adaptable and adjust valuation techniques accordingly.
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Self-Reliant Valuation: Instead of relying on third-party analyses or media reports, Damodaran encourages readers to use the tools provided to create their own assessments, helping them avoid the pitfalls of groupthink or inaccurate market predictions.
By focusing on these elements, the book empowers investors to make better-informed decisions when building long-term portfolios.
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