Investors can improve their returns by removing bad quality stocks. Hans Heytens, Head of Research at the belgian Merit Capital explains us how investors can do this. An example of bad quality is having a return on capital lower than the cost of capital. Other examples lower returns on both equity and on assets. Heytens has a preference for smallcaps that have high payout ratios instead of companies that reinvest a lot. When you use these kind of filter techniques you can expect the same kind of returns also for bigger companies (like large and mega caps). This because of the general quality factor.
For banks Hans uses special screeners. Hans warns for not spreading too much as then portfolios get over diversified and then have higher chances of missing quality premia. As examples Hans refers to smart beta funds and ETF's of which most of them contain very high numbers of stocks.