The Quality Funnel

Many stocks few quality companies.

The Universe of Stocks

There are tens of thousands of publicly traded companies around the world—over 55,000 listed across roughly 80 major exchanges.

In the United States alone, more than 5,600 stocks are traded on the New York Stock Exchange and Nasdaq. That’s a massive pool of options.

While having choices is usually a good thing, in investing, too many options can actually make the decision-making process harder—not easier.

According to historical data, the most common outcome for an individual stock is a 100% loss. In fact, 55% of U.S. stocks have underperformed even short-term U.S. Treasury Bills, and the median stock has failed to keep up with the broader market over time.

Yet, paradoxically, stocks have also been the best-performing asset class over the long run. How can both things be true?

It all comes down to the power of a few winners. A small group of high-quality companies has historically driven the bulk of long-term stock market returns.

This reinforces a classic investing principle: for most people, the smartest strategy is to invest in low-cost index funds and let time and compounding do the heavy lifting.

The Quality Funnel

If you're not content with settling for average market returns through index funds, the next logical step is to focus on identifying the select few high-quality stocks that actually drive the market's long-term gains.

Let’s explore just how much of the market we can filter out using a handful of simple, reasonable metrics.

Out of the 5,644 U.S. stocks trading on the NYSE and Nasdaq, here’s how many pass some basic quality criteria:

• 2,014 stocks have a dividend yield greater than 0%

• 2,146 have a payout ratio below 100%

• 1,336 show a positive 3-year dividend growth rate (DGR)

• 1,198 have a positive 5-year DGR

• 641 are rated with a Wide or Narrow Economic Moat

• 1,032 hold an Exemplary or Standard Stewardship Rating

• 2,727 have a positive 3- and 5-year revenue growth rate

• 929 show a positive 3- and 5-year earnings per share (EPS) growth

• 2,235 report a positive return on invested capital (ROIC)

Individually, none of these filters are especially strict. They're broad, reasonable, and widely accepted indicators of business quality. But what happens when we combine all nine?

Let’s walk through the funnel:

• 5,644 – Starting universe

• 2,014 – Dividend yield > 0%

• 1,381 – Payout ratio < 100%

• 1,019 – Positive 3-year DGR

• 890 – Positive 5-year DGR

• 300 – Wide or Narrow Economic Moat

• 299 – Exemplary or Standard Stewardship

• 258 – Positive 3 & 5-year revenue growth

• 188 – Positive 3 & 5-year EPS growth

• 171 – Positive ROIC

After applying these basic filters, we’re left with just 171 stocks—roughly 3% of the original universe. That means 97% of U.S. listed stocks are filtered out.

And remember: none of these filters were aggressive. This is a powerful demonstration of just how rare truly high-quality companies are.

The Kicker

Of course, even after all that filtering, the list of 171 stocks isn’t perfect.

Some bad apples likely slipped through—companies that just happen to check all the boxes on paper but don’t hold up under deeper scrutiny. At the same time, there are probably some truly outstanding businesses that didn’t make the cut simply because they didn’t meet one or two rigid criteria.

That’s the limitation of any mechanical stock screener: you can't fully capture the essence of quality with a checklist. Great companies don’t always fit neatly into boxes.

But here’s the key insight: we don’t need to find all the winners, and we don’t need to avoid every loser.

What we do need is for our process to consistently lean toward more winners than losers. If we can tilt the odds even slightly in our favor, then over time, compounding will do the heavy lifting—leading to significantly better long-term results compared to simply matching the market.

What’s Next

The final high-quality investable universe will be built using the 9 screening criteria I shared today. That said, I may tighten some of the thresholds after further analysis. The goal is to narrow the list to roughly 100 carefully selected stocks.

Of course, even the best screener isn’t perfect. So in addition to the quantitative filters, a manual review will be necessary. In the short term, a quick scan can help eliminate any obvious red flags. But over the long term, I plan to conduct deeper fundamental dives into each stock to ensure only the highest-quality businesses make the cut.

Here’s the timeline:

• By the end of June: Finalize the investable universe

• July 1st: Launch the actual portfolio

• Post-launch: Begin releasing deep-dive analyses on each stock, starting with companies I haven’t covered before

If you missed it, make sure to check out the first post in this series where I introduced The Quality Portfolio.