I screen a lot looking for quality companies. Quality companies are not hard to identify. They are companies with above average growth rates, above average profitability, expanding margins, positive earnings surprises, low debt levels, high operating leverage, etc., etc..
I was watching William Black's presentation "The Great American Bank Robbery" and it reminded me of some thoughts. Namely, that the naive process of screening for "quality" companies often throws up a number of duds and dupes. These are companies that look good on paper, but are rotten beneath the surface. Black refers to red flags related to companies exhibiting huge growth rates, monster margins and always beating the number. He argues that the growth rates and the "always beat" are often hallmarks of an environment where bad ethics is driving out good ethics. The weapon of choice for white collar crime is accounting fraud. Sometimes, when it is too good to be true, it is too good to be true.
Foreign companies (especially Chinese companies) often exhibit these characteristics, so it is always buyer beware. However, the measure I have come across to cross reference the quality of a company is the level of short interest. The short guys (at least those who specialize in it and not necessarily the hedge guys who simply run long/short portfolios) always seem to sniff out accounting fraud, or a broken business model, or a company/industry in secular decline, or fads. They do their homework and have a healthy dose of skepticism.
Black, to his credit, also holds no punches when he calls the Big Four accounting firms and the credit rating agencies failures - ouch!
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