This document explores the concept of behavioral finance, focusing on quality stocks defined by profitability, growth, low risk, and high payouts. The authors find that quality stocks yield higher risk-adjusted returns compared to junk stocks, and analyze the performance of quality portfolios during major economic crises. It also discusses portfolio construction based on quality scores and outlines results and performance metrics over time.

1. Behavioral
Finance
Submitted By: Group 10
0011/58 Ashish Panwar
0044/58 Lakhshya Khurana
0054/58 Anirudh Agarwal
0128/58 Arun Yadav
0166/58 Simran Diwedi
0167/58 Adarsh Gupta
0179/58 Shubham Kalani
0216/58 Pulkit Pandey
Quality Minus Junk

2. INDEX
03
04
05
Hypothesis
01
Variables
Portfolio Analysis
Portfolio Construction
Data
02
06 Performance During Crisis

3. Hypothesis & Theory
01
Quality stocks are defined as stocks that have high profitability, high
growth, low risk, and high payouts.
02
03
04
Logically, the prices of such stocks should demand a premium over other
stocks and thus should yield lower returns on a long-term basis.
But authors find that the price premium being paid by investors for
quality stocks is not sufficient, which results in higher risk-adjusted
returns on quality stock and negative risk-adjusted returns on junk stocks.
Prices and returns are naturally connected, and authors have shown that
the price of quality negatively predicts the future return on QMJ.

4. Hypothesis & Theory
05
Authors theorize that market prices may be based on superior quality
characteristics( some omitted variable/s), explaining limited power of
quality of prices.
06
07
08
The quality characteristics may be correlated with risk factors not
captured in the risk adjustments, explaining lack of captured risk in a
quality security leading to lower returns.
Market prices may fail to fully reflect the characteristics linked to
behavioral finance or some other constraints
QMJ strategy is different from HML(High-minus-low), in fact both are
negatively correlated. QMJ is based on quality characteristics irrespective
of prices, while HML is based on stock prices.

5. Data
Dataset is collected from CMIE Prowess IQ database.
Following parameters for all BSE 500 stocks are compiled:
Closing price of the stock
Beta & Market Cap
Revenue, EBIT, PAT, OCF, Total Assets, Equity
Incorporated year
Dividend
Data is then cleaned for any missing data.

6. Variables
Now, it is essential to generate a quality score based on 3 quality measures:
• Profitability: Using sustainable part of profits in relation to the book values;
including measures such as return on equity, return on assets, and cash flows over
assets.
• Growth: Parallelly, we see the growth in the sustainable profits metrics in relation
to the book values; which include ROE, ROA, cash flow over assets 3-year growth
rates.
• Safety, which includes stocks with low market beta, volatility, and leverage.
For every factor, we normalize the score for all companies and create a normalized
factor score, which are all added to create a final quality score.
* A 4th factor, Payout might also be added, including net equity issuance, net debt
issuance, and total net payout over profits.
Quality = z ( Profitability + Growth + Safety)

7. Portfolio Construction
Portfolio is developed by ranking Quality score composite.
Quality stock portfolio constitute Top 10 stocks ( Equal-weighted) based on Quality
score of a particular year.
Junk stock portfolio constitute Bottom 10 stocks ( Equal-weighted) based on Quality
score of a particular year.
Portfolio is rebalanced at the end of every year.
Return of the Portfolio is calculated at the end of every year.

8. Portfolio Analysis
CAGR=18.2% CAGR=17.1%
0
500
1000
1500
2000
2500
3000
3500
4000
Quality Portfolio Value
0
500
1000
1500
2000
2500
3000
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
Junk Portfolio Value

9. Performance during 2008 GFC & 2020 COVID Crisis
The Quality portfolio has higher returns during 2008 GFC and 2020 COVID crisis than
Junk portfolio.
This result is in line to our hypothesis that quality outperform junk during crisis.
There could be several reasons that our paper could not able to replicate the
hypothesis in year 2009. One of the reason could be:
No diversification : Portfolio has only 10 stocks
0
50
100
150
200
250
2008 2020
Performance During Shock
Quality Junk
-3.7
32.7
-110.4
45.2
11.4
44.4
61.6
-33.2
83.2
-25.6
-23.8
8.6
-27.2
34.8
30.3
20.8
34.9
-24.7
-15.6
-3.3
20.7
-150.0
-100.0
-50.0
0.0
50.0
100.0
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
Quality - Junk

10. THANK YOU!

11. Appendix 1-2008
2008-Quality 2008-Junk

12. Appendix 2-2020
2020-Quality 2020-Junk