With fluctuations in the AI trade, Wall Street is optimistic about quality stocks. Recently, institutions such as Morgan Stanley and Goldman Sachs have recommended this factor to their clients.

Piper Sandler has also joined this camp. Last week, the firm released a guide to quality factor trading to its clients, stating that quality stocks are expected to continue to rise in value.

The chief investment strategist and head of portfolio strategy, Michael Kantrowitz, wrote in the report: "We believe that the current market environment is conducive to quality themes outperforming the broader market."

Piper Sandler has its own definition of "quality." It emphasizes a higher free cash flow yield, a higher return on equity, a higher return on invested capital, a higher return on assets, as well as a higher interest coverage ratio. These terms may sound complex, but in essence, they are all methods for measuring the financial health and profitability of a company.

As for lower debt levels and higher dividends – which are also common criteria of quality factors – Piper Sandler believes their importance to be relatively low.

This line indicates that quality stocks usually perform best when the market declines from its highs, and it seems that the current cycle that stocks are in is part of this phase.

As the market moves towards 2027, the macroeconomic prospects for the broader market are deteriorating, which should prompt investors to turn to higher-quality stocks in search of more stable companies in order to reduce portfolio risk.

For example, both short-term and long-term interest rates are rising before the New Year, and historically, this is usually not conducive to stock market performance. Oil prices remain high, there is a low willingness for fiscal spending, and housing activity is slowing down.

Kantrowitz indicates that, compared to betting on specific industries, one advantage of focusing on quality factors is that this approach covers every corner of the market.

This line mentions several ways to participate in the quality theme. The first one is to select individual stocks using its Macro Select filter.

This filter examines return on equity, profit momentum, free cash flow yield, as well as whether there are any "red flag" signals lacking in their selling model.

The following are the top 9 stocks in this Macro Select model, and the market value of each of these companies exceeds $100 billion.

Investors can also obtain exposure to quality stocks through exchange-traded funds ( ETF ).

Piper Sandler has selected 20 quality factors ETF and ranked them based on profitability, valuation level, and earnings momentum.

The following lists the top 5 funds with the highest comprehensive rankings under these three themes.