Currently, some of the discussion points out in the industry out there revolve around “Quality vs Value stocks”. I would like to weigh in with my perspective. The concept of quality is familiar. People make judgements about it every day. Yet articulating a clear definition of quality is challenging. Open most dictionaries and you will see a dozen or more sub-definition for it but none of which makes any reference to quality in corporate or investing context. One of the best explanation appears in ‘’Zen and the Art of Motorcycle Maintenance’’ that ‘’…even though Quality cannot be defined, you know what Quality is!’’ Quality investing is a way to pinpoint the specific traits, aptitudes and patterns that increase the probability of a particular company prospering over time – as well as those that decrease such chances.
As mentioned in the book ‘’Quality Investing: Owning the best companies for the long term’’ by Torkell T. Eide, Patrick Hargreaves & Lawrence A, Cunningham, ‘’Three characteristics indicate quality. These are strong predictable cash generation; sustainably high returns on capital; and attractive growth opportunities. Each of these financial traits is attractive in its own right, but combined, they are particularly powerful, enabling a virtuous circle of cash generation, which can be reinvested at high rate of return, begetting more cash, which can be reinvested again.’’ It is relatively easy to identify a company that generates high returns on capital or which has delivered strong historical growth – there are plenty of screening tools which make this possible. The more challenging analytical endeavour is assessing the characteristics that combine to enable and sustain these appealing financial outputs. While I remain watchful on the ongoing earnings season, we continue to maintain a positive bias in favour of quality and strong balance sheet stocks.