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Introducing Earnings Quality: A Systematic Equity Strategy Factor

In this Research Insight, we introduce Earnings Quality, one of the Systematic Equity Strategy (SES) Factors modeled by MSCI Equity Analytics Research. This paper finds that the Earnings Quality factor can help interpret drivers of risk and return, especially when a stock price peaks. At such turning points, weak firms may have a strong incentive to beat earnings.  The Earnings Quality factor can help detect earnings management intended to boost the bottom-line, thus identifying companies of poor quality that warrant further investigation. A security’s drift from high to poor earnings quality, or the negative drift of a sector or portfolio’s aggregate earnings quality, might portend poor performance.