Why do markets reward investors for holding stocks that usually provide excess returns over low-quality ones?
Of all the factors associated with long-term outperformance by equities, quality is the most puzzling. Because investors demand a return premium for incurring risk, it is easy to understand why small company stocks have outperformed over long time frames: they are more volatile and less liquid than large-capitalization stocks.
Value stocks – which tend to have more debt, slower growth rates and higher costs of capital than growth stocks do – also have earned a value premium over the long run. But why should markets reward holders of quality stocks with excess returns over those holding low-quality stocks? It is counterintuitive
