“I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years.” Warren Buffett
The AssureInvest Australian Equities portfolio has a strong performance record. Importantly, our focus on outstanding businesses trading at reasonable value means returns are generated at lower risk. The approach is tried and tested.
Investing takes experience, time, discipline and commitment to thoroughly analyse company and industry fundamentals, thus setting up investors to preserve capital and generate superior and more certain returns.
To their detriment, too many investors chase quick gains by taking bets on hard to predict factors like volatile commodity prices or next year company earnings. Others are ruled by emotions and follow the herd or anchor decisions on recent trends assuming they will last indefinitely.
In addition to our own extensive experience, empirical evidence supports a long-term focus on high quality.
In Quality Minus Junk (2013)
Asness, Frazzini, and Pedersen studied data in the US from 1956 to 2012 and globally from 1986 to 2012. Quality companies were defined as safe, profitable and growing with a high payout ratio. They found quality companies command higher prices on average, but the quality characteristic had little relationship with the prices at which they traded. As a result high-quality companies exhibit desirable high risk-adjusted returns.
The authors found a portfolio long (positive exposure) in quality stocks and short (negative exposure) in junk stocks earned significant risk-adjusted returns in the US and globally in 24 countries. They noted that quality stocks tend to have low beta (correlation with market returns) and benefit from “flight to quality” where they perform relatively well in periods of extreme market distress.
In The Other Side of Value: The Gross Profitability Premium
by Robert Novy-Marx (Journal of Financial Economics, 2013, vol. 108, issue 1, pages 1-28), the author found that profitable firms, measured by gross profits-to-assets, generate significantly higher returns than unprofitable firms, despite having significantly higher valuation ratios.
The Case for Quality – The Danger of Junk
in 2004 by investment manager GMO LLC, showed high quality companies easily outperformed low quality among US S&P 500 stocks between 1971 and 2004. They observed: “It appears that investors overpay for higher risk stocks and underpay for less risky stocks”. GMO defined high quality companies as those with low leverage, high profitability and low earnings volatility.
Higher-quality companies tend to have lower market risk
Low beta stocks are less reliant on the overall market for performance and will tend to outperform in periods of negative market returns (beta measures the proportion by which a company’s share price shares in a 1% rise or fall in the overall market). A study by S&P Capital IQ found that companies that grew earnings and dividends more consistently tended to experience lower share price volatility relative to the rest of the market.
The researchers developed an S&P Earnings and Dividend Quality Rank and assigned a rating to all S&P 500 companies based on their 10-year history of earnings and dividends to April 2014. They found that stocks with “Above Average” rankings had an average beta of 0.94, compared with the average beta of 1.41 for those ranked as “Below Average” and 1.07 for those ranked “Average”.
AVERAGE S&P 500 COMPANY BETA BY S&P CAPITAL IQ QUALITY RANK
Our high-quality bias
The companies AssureInvest targets have sustainable competitive advantages leading to persistently high returns on capital, reliable cash flows and strong balance sheets.
- By reinvesting capital at high rates of return, competitively advantaged firms become compounding machines, creating extraordinary value for investors over time.
- We want companies to generate strong free cash flow, so they will have strong margins and limited need to invest capital in the business. They should also have growth potential by selling into a growth market or being able to raise prices over time.
- We don’t buy a business just because it is part of an index. We would prefer to have a small number of very high quality businesses than a lot of weak ones.