Quality at a Reasonable Price (QARP) Investing: 5 Steps to Build a Stock Portfolio Like Warren Buffett

Quality at a Reasonable Price (QARP) investing combines the best of both worlds — the safety of quality companies with the upside potential of reasonable valuations.

It’s the strategy Warren Buffett shifted to after learning from Philip Fisher, and it’s how Terry Smith has delivered 14% annual returns for over a decade.

In this guide, I’m breaking down exactly how to build a QARP portfolio using the same metrics professional investors rely on.

You’ll learn which quality factors actually predict long-term outperformance, how to identify reasonable prices without falling into value traps, and which stocks are hitting the sweet spot right now.

Let’s dive in.

P.S. Want to jump right to the picks? Get our top 5 QARP stocks to watch here.

What is Quarp Investing?

Quality at a reasonable price — QARP for short — isn’t about chasing the cheapest stocks or overpaying for the best businesses. It’s about finding high-quality companies trading at valuations that make sense relative to their growth, profitability, and sector norms.

Here’s the thing: industries differ dramatically in capital intensity, margins, and valuation multiples. True QARP investing requires relative thresholds, not rigid rules. A software company’s quality metrics look nothing like a retailer’s — and that’s perfectly fine.

Here’s the framework I use to identify genuine QARP opportunities. I’ll explain the process first, then take a deeper dive into the criteria to help you on your journey.

Building Your QARP Portfolio: My 5-Step System

First off, let me walk you through exactly how I construct a QARP portfolio from scratch.

Step 1: Screen for Quality First

Start with quality, not price. Run screens for companies with:

• ROIC > 15% (3-year average)
• Free cash flow margin > 15%
• EPS growth > 10% (5-year average)
• Debt-to-equity < 0.5

This typically generates 200-400 companies from the investable universe. Don’t worry about valuations yet.

To uplevel your list, verify by checking the Zen Rating of each stock on WallStreetZen — you should only move forward with stocks that have an A or B rating. Go ahead, enter any ticker here.

Step 2: Apply Valuation Filters

Take your quality list and layer in valuation screens:

• P/E ratio below sector median
• PEG ratio < 1.5
• Free cash flow yield > 4%

This narrows your list to 50-100 companies that combine quality characteristics with reasonable valuations.

Once again, run any picks through the Zen Ratings system to see not only how they fare overall, but how they fare on our Value Component Grade. You can see this grade on any ticker’s page, below the main Zen Rating. For example:

Step 3: Fundamental Deep Dive

Now comes the critical part — qualitative analysis. For each remaining candidate:

Understand the business model. How does it make money? What are its competitive advantages? Could a competitor easily replicate its success?

Assess management quality. Review the last five years of shareholder letters. Does management clearly articulate strategy? Do they allocate capital wisely? Have they delivered on past promises?

Analyze industry dynamics. Is the industry growing or declining? What are the major risks? Are competitive dynamics intensifying or moderating?

Review recent developments. Has anything changed fundamentally in the past year? New regulations? Competitive threats? Management changes?

This step requires actual research and judgment. I typically spend 2-3 hours researching each potential position before buying.

Once again, the Zen Ratings system can help you here. Enter any ticker on WallStreetZen and you can get a quick read on company news, price movement, insider buying and selling activity, and more. 

Additionally, if you’re looking for guidance in terms of stocks to follow right now, consider subscribing to our FREE newsletter — we send out a lot of investing inspiration every week, including a list of 5 stocks to watch every Sunday.

Step 4: Position Sizing and Portfolio Construction

Once I’ve identified 15-25 companies that meet my QARP criteria, I construct the portfolio:

Equal-weight or conviction-weight. I typically start with equal-weighted positions (4-5% each), then adjust based on conviction and risk. My highest conviction positions might get 7-8%, while lower conviction names stay at 3-4%.

Sector balance. I aim for reasonable sector diversification to avoid concentration risk. No sector gets more than 25% of the portfolio.

Maintain 10-15% cash. Cash gives you flexibility to add to positions during corrections or take advantage of new opportunities. But remember — that cash shouldn’t just be lying under your mattress. I suggest putting it in high-yield savings or a high-yield cash account. 

Right now, the brokerage moomoo offers one of the best high-yield rates for uninvested cash — up to 8.1% APY.

Step 5: Monitoring and Rebalancing

QARP is not a set-it-and-forget-it strategy. I review positions quarterly:

Quality deterioration. If ROIC falls below 12% for two consecutive quarters or free cash flow turns negative, I investigate whether the business model is breaking down.

Valuation expansion. When stocks appreciate to P/E ratios above sector average by 20%+ and PEG ratios above 2.0, I trim or eliminate positions. The “reasonable price” component matters.

Better opportunities. If I find new QARP candidates that score significantly higher on quality metrics at similar or better valuations, I’ll rotate capital.

I typically make 4-6 portfolio changes per year — enough to keep quality high and valuations reasonable, but not so much that I’m constantly churning.

Criteria for QARP Stocks

Now that you understand the basic process of building a QARP portfolio, let’s dig into some of the finer points about criteria. 

1. ROIC Meaningfully Above Sector Median

High returns on invested capital signal a durable competitive advantage. But ROIC varies wildly across industries, so I don’t use a single hard cutoff.

Instead, I look for ROIC comfortably above the company’s sector median — ideally 30-50% higher.

This approach captures genuine quality without penalizing structurally lower-ROIC industries like healthcare or retail.

A healthcare company with 12% ROIC might represent exceptional quality if its sector median is 8%. Meanwhile, a software company at 18% ROIC could be mediocre if its peers average 25%.

The key is relative outperformance within the competitive landscape.

2. Consistent Double-Digit Earnings Growth

Quality shows up clearly in the income statement. I want to see 10%+ EPS growth over the past 3-5 years with low volatility and at most one down year.

This removes cyclical businesses and low-quality growers from consideration. Consistent growth matters more than occasional spikes followed by crashes.

Companies that deliver steady 12-15% annual earnings growth year after year demonstrate the kind of predictable quality that compounds wealth.

3. Strong and Stable Free Cash Flow Generation

The best businesses convert earnings into actual cash. Accounting profits mean nothing if they don’t translate to cash you can reinvest or return to shareholders.

I look for free cash flow margins above industry norms and consistent FCF growth over time.

High cash generation allows companies to reinvest in growth, buy back stock, pay dividends, and weather downturns without taking on debt. It’s the ultimate quality signal — cash doesn’t lie.

4. Prudent Balance Sheet Relative to Sector Norms

Quality companies don’t rely on excessive leverage to grow.

Instead of rigid debt-to-equity ratios, I evaluate balance sheet strength relative to industry standards. A capital-light software firm should carry minimal debt. A healthcare or retail business may appropriately carry more due to working capital needs and capital intensity.

What matters is that debt levels and interest coverage metrics are conservative for the company’s specific industry. I want to see companies that could survive a severe recession without risking financial distress.

5. Durable Competitive Advantages

Numbers alone don’t create quality. I need to see evidence of a genuine moat — structural reasons why competitors can’t easily replicate success.

Network effects, brand strength, switching costs, scale advantages, and regulatory barriers all create durable moats. Companies with true competitive advantages maintain high ROIC and stable margins for years, even as competitors attack their markets.

I spend time understanding the source of each company’s moat before investing. If I can’t articulate why a business will still dominate in five years, I skip it regardless of current metrics.

Valuation Criteria: ‘Reasonable’ Doesn’t Mean ‘Cheap’

QARP recognizes that great businesses often trade at premiums — and deserve to. But those premiums must be reasonable relative to peers and growth prospects.

Forward P/E at or Near Sector Median

Rather than demanding discounts, I look for P/E multiples in line with — or not excessively above — industry norms. Specifically, I want forward P/E within about 20-30% of the sector median.

This approach avoids paying extreme premiums while acknowledging that sectors like software naturally trade at higher multiples than industrials or retail.

A software company at 28x forward earnings when its sector trades at 25x is reasonable. The same company at 45x when peers trade at 25x is expensive, regardless of quality.

PEG Ratio Below 1.5 (Up to 2.0 for Exceptional Moats)

The PEG ratio adjusts valuation for growth expectations, which helps compare companies with different growth profiles.

My rule: PEG under 1.5 for most companies, but I’ll accept up to 2.0 for businesses with world-class economics like Microsoft, Visa, or Costco.

A quality company growing earnings 20% annually with a P/E of 30x has a PEG of 1.5 — reasonable given the growth profile. The same company at a P/E of 45x (PEG of 2.25) has moved beyond “reasonable” into momentum territory.

This flexibility matches real-world QARP practice used by successful managers like Terry Smith and Chuck Akre, who occasionally pay up for truly exceptional businesses.

Free Cash Flow Yield Appropriate for Industry and Growth Profile

Rather than setting a single minimum FCF yield for all companies, I evaluate whether the yield makes sense relative to peers and is justified by the company’s durability and growth rate.

A fast-growing software company generating 3% FCF yield can be reasonable if peers yield 2% and the company is reinvesting heavily for expansion. A mature industrial company at the same 3% yield might be expensive if peers yield 6%.

Context matters. I compare FCF yields within sectors and adjust expectations based on growth rates and capital requirements.

The magic of QARP is this: quality compounds over time, and reasonable valuations provide a margin of safety. You get downside protection from strong fundamentals and upside potential as the market recognizes quality that was underappreciated.

Why Professional Investors Love QARP Strategies

Professional investors gravitate toward QARP because it works across market cycles — unlike pure momentum or deep value strategies that have extended periods of underperformance.

Warren Buffett’s evolution illustrates why QARP wins long-term. Early in his career, Buffett focused on “cigar butt” investing — buying terrible companies at prices so cheap you could get one more puff.

Then he met Charlie Munger and Philip Fisher, who taught him that it’s “far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”

The result? Berkshire Hathaway’s greatest positions — Coca-Cola (KO), American Express (AXP), Apple (AAPL) — were all QARP investments. Quality companies purchased at reasonable valuations that compounded for decades.

Terry Smith runs one of the UK’s most successful funds using a pure QARP approach. His Fundsmith Equity Fund has delivered 14% annualized returns since 2010 by focusing exclusively on high-quality companies with strong returns on capital, bought only when valuations are reasonable.

Smith’s portfolio includes companies like Microsoft (NASDAQ: MSFT), L’Oréal, and Stryker — names that would never appear in a traditional value screener but aren’t trading at crazy momentum multiples either.

Academic research supports QARP’s effectiveness. Multiple studies show that combining quality factors (profitability, balance sheet strength, earnings stability) with value factors (low P/E, low P/B) produces better risk-adjusted returns than either approach alone.

The reason is simple: quality protects you in downturns while reasonable valuations provide upside. You avoid both value traps (cheap junk that stays cheap) and momentum crashes (expensive stories that implode).

I’ve personally used QARP principles for years because it matches my temperament. I want to own businesses I understand, with fundamentals I trust, at prices that don’t require heroic assumptions to justify.

The Key Metrics for Identifying QARP Stocks

Building a QARP portfolio starts with the right screening criteria. Here are the specific metrics I use:

Quality Metrics

Return on Invested Capital (ROIC) > 15%

ROIC measures how effectively a company converts invested capital into profits. I want to see ROIC above 15% sustained over at least three years. This indicates genuine competitive advantages — not just a lucky year.

Companies like Microsoft, Visa, and Adobe consistently generate ROICs above 20%, which is why they compound shareholder value so effectively.

Earnings Growth Rate > 10% annually

Quality companies grow earnings consistently. I screen for companies with 10%+ EPS growth over the past three and five years, with no more than one down year in that period.

This filters out cyclical businesses that might show high average growth but with massive volatility.

Free Cash Flow Margin > 15%

Free cash flow margin (free cash flow divided by revenue) tells you how much actual cash a business generates from its operations. I prefer margins above 15%, which indicates efficient operations and pricing power.

Cash generation matters more than accounting earnings. Companies that generate strong free cash flow can reinvest for growth, pay dividends, and buy back shares without relying on debt or dilution.

Debt-to-Equity Ratio < 0.5

Quality companies don’t need excessive leverage. I screen for debt-to-equity below 0.5, which indicates conservative balance sheets that can weather economic downturns.

Some capital-intensive industries (utilities, REITs) naturally carry more debt. In those cases, I adjust the threshold but still prefer companies at the lower end of their sector range.

Valuation Metrics

P/E Ratio: Below sector median

I compare each stock’s P/E to its sector median. Quality companies typically trade at premiums, so I’m not looking for the cheapest P/E in absolute terms. Instead, I want quality companies trading below their peer group average.

PEG Ratio < 1.5

The PEG ratio adjusts P/E for growth expectations. A PEG below 1.0 is ideal (suggesting you’re paying less than 1x the growth rate), but I’ll accept up to 1.5 for exceptional quality companies.

A quality software company growing earnings 25% annually with a P/E of 30x has a PEG of 1.2 — reasonable given the growth profile.

Free Cash Flow Yield > 4%

I calculate free cash flow yield by dividing free cash flow per share by stock price. Yields above 4% indicate reasonable valuations relative to cash generation.

This metric is particularly useful for comparing across sectors with different growth profiles and accounting treatments.

How I Combine These Metrics

I don’t require perfection across all metrics. A company might have a slightly higher debt-to-equity ratio if its ROIC is exceptional and it’s trading at a compelling valuation.

The goal is finding companies that score well across most quality and valuation factors — not waiting for the mythical “perfect” stock that checks every box.

In practice, I prioritize ROIC and free cash flow generation above all else. Companies that score highly on these metrics tend to be genuine quality businesses, even if they’re temporarily weaker on other factors.

Common QARP Investing Mistakes to Avoid

I’ve made every QARP mistake in the book. Here are the traps to watch for:

Mistake 1: Confusing “Cheap” With “Reasonable”

QARP isn’t deep value investing. You’re not looking for 8x P/E ratios or companies trading below book value. Those are often value traps — cheap for good reasons.

A quality company at 22x earnings can be “reasonable” if it’s growing 15% annually with strong ROIC. The same company at 40x earnings is expensive. The same company at 10x earnings probably has fundamental problems.

Don’t let traditional value investor instincts sabotage your QARP strategy.

Mistake 2: Ignoring Valuation Because “Quality Always Works”

The flip side error: buying quality at any price and assuming it’ll work out.

I’ve owned “quality” stocks that went nowhere for years because I overpaid. Cisco Systems was unquestionably a quality company in 2000. It also traded at 150x earnings. Two decades later, it still hasn’t reclaimed those highs despite growing earnings substantially.

Price always matters eventually.

Mistake 3: Falling for “Story” Over Substance

Growth investors love narratives. “AI will revolutionize everything!” “This company is the next Amazon!”

QARP requires showing me the numbers. I don’t care about potential — I want to see current ROIC, actual free cash flow, and demonstrated competitive advantages. If the fundamentals aren’t there today, it’s not a QARP stock regardless of the story.

Mistake 4: Holding Too Long After Quality Deteriorates

Quality can disappear faster than you think. Management changes, competitive dynamics shift, business models age.

When ROIC starts declining consistently or free cash flow turns negative, investigate immediately. Don’t hold onto the memory of what a company used to be.

I use a simple rule: if ROIC drops below 12% for two consecutive quarters without a clear temporary explanation, I’m selling or at minimum reducing position size significantly.

Mistake 5: Neglecting Diversification

Even quality companies face company-specific risks. Regulatory changes, product failures, accounting scandals — unexpected events happen.

I never put more than 8% of my portfolio into a single position regardless of how high quality it appears. And I maintain exposure across at least six different sectors.

Concentration builds wealth, but only if you’re right. Diversification protects wealth when you’re wrong.

QARP vs. Other Investment Strategies

Understanding how QARP differs from other approaches helps clarify when to use it.

QARP vs. Deep Value Investing

Deep value focuses on statistical cheapness — low P/E, low P/B, high dividend yields. The thesis is mean reversion: cheap stocks will eventually be recognized as undervalued.

QARP doesn’t chase the cheapest stocks. Instead, it seeks quality first, then reasonable valuations. You’ll pay up for better businesses.

When deep value works: Market dislocations, cyclical industry bottoms, unfairly punished sectors.

When QARP works better: Normal market environments, when you want consistent compound returns without the drama of turnarounds and value traps.

I use both strategies but keep them separate. My QARP portfolio is core holdings I expect to compound steadily. Deep value positions are smaller, more tactical bets.

QARP vs. Growth Investing

Growth investing prioritizes revenue and earnings growth above all else, often accepting high valuations for companies with compelling growth stories.

QARP requires growth (10%+ earnings growth minimum), but won’t pay infinite multiples. You’re buying growth at reasonable prices, not at any price.

When growth investing works: Early stages of bull markets, when liquidity is abundant and investors value momentum over fundamentals.

When QARP works better: Late-cycle markets, when valuations are stretched and quality-with-discipline outperforms momentum.

If the market is pricing in perfection, QARP’s valuation discipline protects you from the inevitable multiple compression.

QARP vs. Dividend Investing

Dividend strategies focus on current income from dividend-paying stocks, often accepting slower growth in exchange for yield.

QARP doesn’t require dividends but appreciates companies with strong free cash flow that can pay dividends if management chooses. Quality companies often return capital through both dividends and buybacks.

When dividend investing works: Low interest rate environments, for investors needing current income, during late-cycle markets when income provides a downside cushion.

When QARP works better: When you prioritize total return over income, and when you want exposure to growth industries where companies reinvest rather than pay dividends.

Many QARP stocks pay modest dividends (2-3% yields) plus buybacks. This combination often beats pure dividend strategies over full market cycles.

Final Thoughts: Building Wealth the QARP Way

QARP investing won’t make you rich overnight. It won’t give you the thrill of 10x returns from speculative bets. And it definitely won’t be the most exciting strategy to explain at cocktail parties.

What it will do: help you compound wealth steadily across market cycles while avoiding the catastrophic losses that wipe out years of gains.

The strategy is simple but not easy:

Find quality companies with strong returns on capital, consistent earnings growth, and durable competitive advantages. Buy them only at reasonable valuations — not bargain basement prices, but not stretched multiples either. Hold them as long as quality remains intact and valuations stay reasonable.

Rebalance when valuations get stretched. Replace positions when quality deteriorates. Stay disciplined.

Professional investors like Warren Buffett and Terry Smith have used QARP principles to generate market-beating returns for decades. Not because they found some secret formula, but because they had the discipline to stick with quality even when flashier strategies seemed more exciting.

I use QARP as my core portfolio strategy because it matches my temperament and goals. I want to sleep well at night knowing I own excellent businesses purchased at prices that make sense.

I want to avoid value traps and momentum crashes. And I want strategies that work across different market environments, not just during specific periods.

Start with a few positions. Learn what quality looks like in different industries. Develop conviction in your valuation frameworks. Build your portfolio gradually as you find companies that meet your standards.

The market will always offer new shiny objects to chase. QARP keeps you focused on what actually drives long-term investment success: owning great businesses at sensible prices and letting compound returns do their work.

Next step: Screen for companies with ROIC above 15%, earnings growth above 10%, and P/E ratios below sector average. Then dig into three candidates and practice your fundamental analysis.

WallStreetZen’s platform makes this process dramatically faster by providing all the key QARP metrics in one place.

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