Quality Never Goes Out Of Fashion: Investing In High-Quality Companies
The defensive virtues of quality stocks are brilliantly illustrated this year. In a world characterised by persistently high uncertainty and major structural developments, quality stocks remain a core holding of choice.
• This theme remains highly attractive. It is still an ideal core portfolio component. Global by nature, it can be applied in all equity markets.
• Companies with strong balance sheets, clear visibility on earnings growth and limited profit variability will remain in high demand.
• They will still be expensive amid weak economic growth and major structural changes.
An exogenous shock highlights the strengths of quality stocks
Quality stocks have a reputation for delivering above-average returns in the late stages of the cycle and especially during recessions. They demonstrated this brilliantly in the first part of the year as the global economy could no longer function normally.
The health crisis has revived investor interest in stocks offering three advantages: limited gearing, high profitability and low profit variability. These three criteria characterise quality stocks.
A core holding in a post-pandemic world
The Covid-19 pandemic is a triple shock: human, production capacity and consumption. Companies will look to diversify their supply chains and digitise their processes. The shock on business volumes and cash flow generation will require limiting capital expenditure.
Adding to this will be a focus on health care, which will lead to a drop in ordinary household spending.
All of these factors, along with the structural trends of deglobalisation and the need for deleveraging, will feed an ongoing appetite for quality stocks, and thereby maintaining their high price.
• The outperformance of quality stocks has been strong (a wide spread above their 200-day moving average). This positive trend calls for a period of digestion.
• The high valuation of quality stocks is their biggest disadvantage.
• A normalisation of economic activity will revive risk appetite, temporarily overshadowing the advantages of quality stocks.