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48An ERI Scientific Beta Publication — The Dimensions of Quality Investing: High Profitability and Low Investment Smart Factor Indices — July 2015Copyright © 2015 ERI Scientific Beta. All rights reserved. Please refer to the disclaimer at the end of this document.AppendixFor example, FTSE proposes quality factor indices which use a factor score for non financial firmswhich is derived from a composite based on operating cash flow to debt, net income to assets (i.e.return on assets or ROA), annual change in sales over assets, and accruals.However, for financials, FTSE chose to use return on assets, as well as a measure they name “ROA-GARP”which consists of the five year ROA growth multiplied by the book-to-market ratio. These two measurescombined lead to the quality score for financials.There are two main issues with this approach. Firstly, it raises the question of the choice of comparableindustries and its sustainability through time. Why should we choose two sets such as financials ornon-financials, and not three or more sets, should market or financial accounting practices changestructurally through time? Secondly, is the issue of the choice of the very proxy for each industryfamily, which increases flexibility in specifying the factor and thus raises robustness issues.Using consistent investment and profitability proxies per industry/industry family while using industryadaptedfinancial items for the proxiesERI Scientific Beta does not have recourse to the two earlier options for profitability nor investmentfactors. Rather, the underlying accounting and financial statement variables used as inputs the twoproxies described earlier are adapted across industry groups.We remind readers of the main variables entering our investment and profitability proxies (seeequations 1 and 2)On the total asset side, there is no reason to differentiate across industries. That is why we use thetotal sum of all the (current and long-term) assets in the balance sheet of the company, regardlessthe industry. For the detail on the Total Assets items currently used, we refer the reader to the listbelow.On the gross profit side, there are differences between industries in the items that are reported bycompanies, notably in their cost of goods sold. One difference lies in the measurement of COGSbetween financial and non-financial companies:• Banks notably bear two specific items called interest expenses on Deposits/Borrowings and provisionfor loan losses/credit losses that make up an important part of their cost base. We thus use thoseitems in the COGS components for banks;• Insurance companies also have specific items in their cost base, such as Amortisation of DeferredPolicy Acquisition Costs, Write off of policy acquisition costs and Underwriting expenses, which weuse in our COGS estimates for this particular industry;• Financial services and brokerage companies use Brokerage charges, Clearance charges, Selling, General& Administrative expenses, Provision for loan losses/credit losses, which we use in the COGS base.For the detail on the COGS, we provide detailed lists below.