It turns out you can put a price on quality. A study finds that
high-quality stocks beat lower-quality issues over the long term.
What's more, high quality tends to do best when you really need it:
in bear markets. Even better, the study concludes that high-quality
stocks are cheap right now.
The Leuthold Group, a Minneapolis-based research firm, found
that high-quality stocks returned an annualized 13.1% from the
start of 1986 through March 2014. By contrast, low-quality stocks
returned an annualized 10.0% over the same period, and Standard
& Poor's 500-stock index returned an average of 10.6% per
What's "high quality"? Like so many investment terms, it suffers
from imprecision. Almost everyone seems to define high-quality
companies slightly differently, but healthy profit margins and low
debt are always common threads.
Leuthold's current high-quality list includes such sturdy stocks
as Apple (symbol
), Berkshire Hathaway B (
), Costco (
), Colgate-Palmolive (
), ExxonMobil (
), UnitedHealth Group (
) and Whole Foods Market (
High quality doesn't win out every year. Far from it.
High-quality stocks outperformed low-quality names in 16 of the
past 28 calendar years, Leuthold found. Analyst Jun Zhu, who
conducted the study, says that's not much better than the result
you'd get by flipping a coin.
But quality has been a friend in stormy seas. In 2008, for
instance, when the S&P 500 plunged 37.0%, low-quality stocks
plummeted 49.4%. High-quality stocks were hardly unscathed, but
they lost only 33.7%.
The 2000 tech explosion provides an even more dramatic contrast.
Low-quality stocks tumbled 17.8% and the S&P lost 9.1% that
year. Yet high-quality stocks gained 13.0%.
Leuthold categorizes companies as high quality or low quality
based on return on equity (a measure of profitability), the ratio
of debt to assets, and the stability of sales and earnings
Leuthold finds high-quality stocks relatively cheap today
compared with low-quality stocks. Based on price-earnings ratios,
high-quality stocks are about 10% cheaper compared with low-quality
stocks than their average over the past 28 years.
Generally speaking, it's easy to identify high-quality stocks.
Just look for companies with healthy profit margins, low debt, and
steadily growing earnings and sales. If you prefer to invest
through a fund, rather than by buying individual stocks, here are
three good choices:
Akre Focus (
), managed by veteran Chuck Akre, invests in the highest-quality
companies Akre and his analysts can find. He looks for sturdy firms
with sustainable competitive advantages. Top holdings include
American Tower (
), Discovery Communications (
) and MasterCard (
). Returns have been streaky but quite good over the long term at
Akre Focus and a previous fund run in the same manner. During the
past three years, Akre Focus, a member of the
, has returned an annualized 20.9%--an average of 5.6 percentage
points per year better than the S&P 500. Expenses are on the
high side at 1.36% annually. (Unless otherwise stated, all returns
are through May 28.)
Market Vectors Wide Moat ETF (
) is an exchange-traded fund that invests in Morningstar's best
picks from among companies its 100-plus analysts view as having big
sustainable competitive advantages. Holdings include Baxter
), Coca-Cola (
) and Procter & Gamble (
). The fund is too new to have a meaningful record, but over the
past five years an identically managed exchange-traded note has
returned an annualized 20.2%, beating the S&P 500 by an average
of 1.7 percentage points per year. The ETF's annual expense ratio
is a reasonable 0.49%.
Vanguard Dividend Growth (
) invests in companies that are both willing and able to hike their
dividends regularly. This is a blue-chip fund that tends to invest
heavily in consumer and health care stocks. Current favorites
include Johnson & Johnson (
), McDonald's (
) and Merck (
). Over the past ten years, it has returned an annualized 9.2%, an
average of 1.5 percentage point per year better than the S&P
index. Expenses are just 0.31% annually. (The fund is a member of
the Kiplinger 25.
is an investment adviser in the Washington, D.C., area. He or his
clients own shares in Apple, Berkshire Hathaway, Coca-Cola and