The quality factor.

LET'S try "quality" as a new watchword in U.S. stock investing, in place of those 1990s standbys growth and value.

Dreyfus Corp., which manages $165 billion in mutual funds, is beating the drum for what it calls a "focus on quality."

Institutional money manager Grantham Mayo Van Otterloo & Co. in Boston recently introduced a portfolio labeled "the GMO U.S. Quality Strategy."

Quality has long been a key point of distinction in bonds, and it's a familiar term among stock investors in many other markets around the world. The timing looks propitious for U.S. stocks as well.

"Some of today's risks cannot be evaluated with the usual tools of economic and market analysis," said Richard Hoey, chief economist and investment strategist at Dreyfus. "Quality companies with strong finances and good business models should be able to prosper even in the event of shocks."

What attracts me to this idea is the need for some better framework than the common growth vs. value and large vs. small categories, both of which have their limitations as systems for setting up a portfolio.

On the small-to-large spectrum, do I really want my fund manager forced to consider selling a top-performing stock because its very success has pushed it into a bigger cap size?

Or should a large-cap discipline require a manager to sell a sleek new little company that emerges from the restructuring of a troubled old giant?

As for growth vs. value, does it really make sense to pursue either to the exclusion of the other? Suppose a long revered growth stock suffers a loss of favor that drops its price temporarily into "value" territory. Should this be cause to exclude it from a growth fund?

The term quality, as opposed to "speculative," provides a potentially clearer way to distinguish between one company and the next. Rather than taking its cue from the size or relative valuation of the company's stock, quality zeroes in on the degree of fundamental risk posed by the company itself.

As with other criteria, quality has to be defined. Grantham Mayo says it screens 600 big stocks for "low leverage, high profitability and low earnings volatility. Failure to meet any one of these criteria excludes a stock from the investable universe."

Jeremy Grantham, GMO's chairman, wrote in a recent letter that quality stocks have "slightly outperformed the market over at least the last 40 years."

And it stands to reason that companies with less debt will be less affected by a rise in interest rates.

While they may miss out on some excitement, quality-stock owners enjoy an emotional benefit over thrill-seeking speculators, Hoey says.

"We believe investors can more easily resist the emotional temptation to mis-time shifts in investment allocations if they hold quality stocks rather than speculative stocks," he says.

"We call this the behavioral benefit of quality."

--Chet Currier, Bloomberg News