After an everything rally that pushed major stock indexes near new highs, some investors just want the good stuff.
After an everything rally that pushed major stock indexes near new highs, some investors just want the good stuff.
They are looking for quality stocks, broadly defined as shares of companies with some combination of growth, reliable profits and strong balance sheets. Those run the gamut from recent highfliers such as Microsoft and Nvidia to steady performers such as Coca-Cola and Johnson & Johnson.
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They are looking for quality stocks, broadly defined as shares of companies with some combination of growth, reliable profits and strong balance sheets. Those run the gamut from recent highfliers such as Microsoft and Nvidia to steady performers such as Coca-Cola and Johnson & Johnson.
Banks including Goldman Sachs, UBS and Wells Fargo recommended that investors buy high-quality stocks in their year-ahead outlooks. GMO, the asset manager co-founded by Jeremy Grantham, launched an actively managed exchange-traded fund focusing on quality, the firm’s first ETF, in November.
One major reason for their interest: High-quality companies tend to do better than others when growth slows—the environment much of Wall Street expects this year—insulated by their steady financial results, low debt, large cash holdings, or other solid business fundamentals. The MSCI ACWI Quality Index has historically beaten MSCI’s global index by 1 percentage point over six-month periods in which the economy has cooled but kept expanding, according to UBS analysts.
That reliability tends to make quality stocks relatively expensive, which means investors might miss out on some gains in a big rally. But for those concerned that the recent surges in stocks and bonds won’t last after a rocky start to the year, seeking quality provides a way to stay invested while potentially cushioning against some of the blow if markets turn. The S&P 500 is up 0.3% to start 2024.
In the coming days, investors will be parsing earnings reports from the likes of Goldman, shipping bellwether J.B. Hunt Transport Services, and oil-field services company SLB while trying to gauge the economy’s strength. Markets are closed Monday for Martin Luther King Jr. Day.
Gerald Goldberg, chief executive at investment adviser GYL Financial Synergies, said his firm adjusted its model portfolios in 2022 to increase exposure to quality companies. A year later, the move had paid off.
“Our theory was that historically, when the economy is slowing down or going into contraction, higher-quality companies would have higher credit ratings and stronger balance sheets,” he said. “Wider moats around their business tend to perform better on a relative basis in comparison to those that are of lower quality.”
The iShares MSCI USA Quality Factor exchange-traded fund gained 29% in 2023, according to FactSet, ahead of the S&P 500’s 24% climb. It lagged behind the index’s 19% decline in 2022, falling 22%.
Some research shows that quality stocks do provide better returns after accounting for risk. A 2013 paper by AQR Capital Management’s Cliff Asness, Andrea Frazzini and Lasse Pedersen, found that despite the higher costs, there are “strong and consistent abnormal returns to quality,” and that a strategy of betting on quality stocks and against shares of weaker companies would earn significant returns in the U.S. and elsewhere.
Allen T. Bond, head of research at Jensen, says quality companies create value through sustainable competitive advantages, growth and financial strength. He also looks for flexibility—things such as free cash flow generation…
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