Are “quality” country stock markets good places to invest? In his December 2013 paper entitled “Quality Investing and the Cross-Section of Country Returns”, Adam Zaremba investigates whether aggregate financial quality determines country stock market performance. Specifically, he uses two-month lagged 12-month data for listed firms to calculate the following eight quality metrics at the country level in each of 66 countries:
- Return on Assets (ROA) – ratio of net income to average assets.
- Return on Equity (ROE) – ratio of net income to average common equity.
- Profit Margin (PM) – ratio of net income to sales.
- Operating Margin (OM) – ratio of operating income to sales.
- Gross Margin (GM) – ratio of gross income (sales minus cost of goods sold) to sales.
- Assets to Debt (AD)- ratio of total assets to short-term plus and long-term borrowings.
- EBITDA to Debt (ED) – ratio of EBITDA to short-term plus long-term borrowings.
- Current Ratio (CR) – ratio of current assets to current liabilities.
He uses MSCI country indexes to measure country market returns. He also calculates for each country the total market capitalization, aggregate book-to-market ratio and 12-month market return momentum. He tests relationships between country-level quality factors and returns by constructing portfolios of the equally weighted top 30% (high-quality), middle 40% (mid-quality) and bottom 30% (low-quality) of country markets based on each quality metric. He also measures for each quality metric the performance of a fully collateralized portfolio that is each month long (short) the equally weighted 30% of country markets with the highest (lowest) quality. To test sensitivity to the currency used, he perform all calculations separately in U.S. dollars, euros and yen. Using monthly accounting and return data as specified during May 2000 through October 2013, he finds that: Keep Reading