What is Factor Investing

Factor investing is a quantitative approach to screen stocks. These can be bucketed into styles like Value, Growth, Low Volatility, Momentum, and Quality.


Factor investing is a quantitative approach to screen stocks that looks at certain financial metrics of a company. Generally speaking, these factors can be bucketed into certain styles like Value, Growth, Low Volatility, Momentum, and Quality. While some individuals, professionals and ETFs can focus on a specific category, often times professionals create blended models such as Low Vol + Quality or dynamic models. Let's uncover each factor style:

Value Investing

Let’s start with Value. Value investing was popularized by the likes of Warren Buffett where the goal is to invest in attractively priced stocks based on valuation multiples like Price-to-Earnings, Price-to-Book and Enterprise Value to EBITDA. The goal with this strategy is to look for companies that are being undervalued by the market either versus history or verse a peer group with the expectation that these stocks will eventually mean-revert to where their peer group trades at. However, one needs to consider why exactly this company is trading below peers or historical averages. If you believe you have an information edge (you know something the market doesn’t), this can be a profitable strategy. Companies that meet the “Value” criteria are generally in cyclical industries like industrials or base materials and respond best out of a recession.

Growth Investing

Often viewed as the opposite of Value, Growth strategies consider earnings growth as the most important criteria to evaluate stocks. Investors typically focus on forward metrics like EPS growth, revenue growth and free cashflow generation. The typical company included in the Growth style would be a technology or healthcare company like FAANG stocks (Facebook, Apple, Amazon, Netflix and Google). Growth-oriented investors have seen consistently high returns in recent years due to rising popularity of tech companies experiencing explosive growth.

Low Volatility

Low Volatility seeks stable returns over maximizing them. This style is typically suited for more risk-averse investors who want capital preservation. They look at factors like Beta (how does the stock move relative to a move in its underlying index) and standard deviation of stock price. Stocks within this category usually encompass stable industries like utilities, banks and real estate — before COVID that is.

Momentum

Momentum is quite the opposite of Low Volatility but utilizes price as it’s main indicator like Low Vol. Individual factors include Price-to-52wk highs, 3-month price change, 9-mth price change and can also include metrics like earnings momentum. Momentum strategies can rotate quite aggressively with a change in leadership but as they use constant data, can react more quickly than portfolios that follow fundamental metrics like Value or Growth look at. Momentum strategies are often better suited to investors with higher risk tolerance due to this increased volatility.

Quality

Quality-oriented styles prioritize profitability over anything else. Factors like ROE (Return on Equity), Free Cashflow, and ROIC (Return on Invested Capital). Because of this, they typically include large, stable businesses like banks, that have paid consistent dividends. Quality-oriented investors fall close to a low-vol investor due to the nature of companies they often pick-up.

Multifactor Models

What exactly are multifactor models? Multifactor models are the next iteration on the single factor models aforementioned. They combine several or all of these factors either using a static weighting scheme or dynamic strategies which adjust a factor's importance to the model depending on its recent performance or macro conditions.

For example, during an inflationary environment, the multifactor model would reduce its growth weighting and increase low volatility and value weights.

Concluding Thoughts

While all of this may sound daunting - ETFs have provided easy access to these factor portfolios. If you need a helping hand in building the perfect ETF portfolio, please check us out at www.investipal.co. We have built a platform that empowers you to research, build and manage your investments in one central place.

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