when investing in stocks it is typically a good idea to focus on valuation and quality while warren buffett began his investing career buying “cigar butts” lowquality but cheap companies with one more “puff” left in them he evolved to focus on higherquality companies with his partner charlie munger’s influence buffett now says that “it’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price” some of buffett’s largest and most successful investments have fit this mold an innovative analysis of the source of berkshire’s investment performance showed that buffett’s “focus on cheap safe quality stocks” was a primary driver of his outperformance in addition the harsh investment environment with a bear market and an impending recession should make inexpensive quality companies even more appealing the avantis us equity etf avus  looks to be an attractive way to inexpensively access this stock market segment via a systematic investment strategy this analysis will delve deeper into the people performance process and most importantly the investment process behind the exchangetraded fund etf avantis is an independent brand and investment team under american century investments american century investments is privately owned with the stowers institute of medical research as the controlling shareholder many in senior leadership at avantis came from dimensional fund advisors dfa a pioneer in fundamental index investing in other words systematically weighting the stock holdings in a portfolio by looking at essential factors like valuation rather than the more typical market capitalization avantis’ chief investment officer eduardo repetto was cochief executive officer cochief investment officer and director at dfa until 2017 avantis us equity etf did not launch until 2019 so it recently reached three years of live performance the performance so far has been encouraging despite the headwinds of larger companies and growth stocks being heavily favored during most of the period avus has outperformed the russell 3000 and sp 500 it has also outperformed yeartodate during the more favorable time for valuetilted strategies avantis uses the russell 3000 index as the benchmark for avus due to its holdings outside of largecap stocks this analysis focuses on the sp 500 though since that is the bogie for many investors avus’ systematic strategy owns stocks across all us market capitalization the exposure to smaller companies should help the longterm performance the maximum individual security weight is 3 except when index market capitalization is higher so etf will remain very diversified the process tilts toward two factors that should drive longterm outperformance valuation and profitability high profitability is often called quality there are no specific rebalancing dates so the etf only changes its holdings when the benefits outweigh the costs this process should lead to lower turnover and limited to no capital gains distributions via the etf structure avus has very reasonable internal expenses of 015 avantis uses these same factors across all its products regardless of market capitalization and geography highprofitability and low valuation companies outperformed lowprofitability and high valuation companies in global stocks the relationship holds across large and small caps in us nonus developed and emerging markets this persistent performance should add confidence that the investment process is robust testing the investment methodology across different types of stocks adds to the dataset and is a standard way to test quantitative strategies avantis uses a modified booktomarket value as the valuation factor the modified booktomarket removes goodwill from the metric goodwill is typically created when two companies merge and unintentionally causes some companies to look cheaper than they should when using traditional booktomarket according to avantis goodwill is now nearly 40 of the aggregate book value of the market so it is meaningful academic literature finds that this adjustment is additive to returns and passes the logical sniff test avantis uses a specific high profitability factor as the quality component this factor uses cashbased profitability which includes excludes accruals many systematic investment processes key on accruals as a negative item since they can be a signal of accounting manipulation academic literature shows that cashbased profitability is superior to net income gross profitability or operating profitability the portfolio currently has its largest overweights in the energy financial and industrial sectors technology communication services and real estate are the most significant underweight sectors this analysis looks at the berkshire portfolio across a host of measures including 12month forward estimated pricetoearnings pe pricetosales ps returnonequity roe enterprise valuetoearnings before interest taxes depreciation and amortization evebitda pricetobook pb dividend yield debttoebitda free cash flow yield and longterm earningspershare growth consensus estimates the valuation measures below the sp 500 and the higher free cash flow yield should be expected given the investment process the higher returnonequity and longterm earnings growth estimates are a testament to using a quality factor rather than just pure valuation the avantis us equity etf avus has a relatively short live track record but the investment team brings a strong pedigree in addition the systematic investment process is fundamentally sound and supported by academic rigor the combination of focusing on valuation and profitability also known as quality has produced strong investment results more tactically the valuation and profitability tilts should perform relatively well in a rising rate environment with economic uncertainty investors should be prepared for the etf’s performance to differ significantly from the market capweighted index the strategy will likely outperform the sp 500 when value quality and smaller market capitalization stocks are in favor