By Kristoff De Turck - reviewed by Aldwin Keppens
Last update: Apr 28, 2023
The easiest way to explain what quality investing exactly entails is to compare this form of investing with the typical value or growth investment.
Whereas the typical value investor looks for low valuation ratios in the hope of buying shares that are quoted well below their intrinsic value, the growth investor will rather focus on high turnover growth, even at the expense of profitability. People invest early in such growth companies in order to achieve very high returns in the near future. Examples of typical growth companies are Netflix (NFLX) and Domino's Pizza (DPZ), for example.
The danger, however, is that typical growth and value characteristics can be misleading. Low-rated stocks can still be expensive if the company in question has a poor outlook, and for growth stocks, only a very small percentage really grow into the mega-success stories that are widely known...
Those who invest in quality abandon that classic contradiction and focus first and foremost on 'good' companies. But what are "good companies"?
As far as this item is concerned, quality investing falls neatly within the boundaries of value and growth investing. Looking for really low valuations however is pointless if you really want to invest in quality companies. Quality has a price, but beware... Not everything that is expensive is necessarily a synonym for quality. That is at least as big a trap as the bargain hunter who buys purely because of a low P/E ratio but ends up with only those companies that nobody else wants....
Market sentiment does strange things to people and certainly to investors. Shares of new hip sounding companies which in no time see their market value increase tenfold or more without ever making a single cent in profit, they certainly exist! However, price is anything but the first criterion a quality investor considers. The fundamentals are the most important and if they are good, a quality investor will be willing to pay an acceptable premium without lapsing into excess.
A typical feature of fundamental investing is a sufficiently long investment horizon. This is certainly true in the case of quality investing which, in this sense, is very similar to the buy-and-hold approach. However, the quality investor is always on his guard and keeps a close eye on the quality foundations on which the company was built. If these start to crumble, the quality investor will, without a doubt, say goodbye to the company in question. The company should therefore continue to be monitored after the purchase, especially if potential competitors gain more ground, it is important to keep a finger on the pulse.
Quality investors should be particularly interested in innovation, especially if that innovation has a significant impact on the activities of the quality companies in which they invest. If the company in which you invest is one of the driving forces behind that innovation, that is certainly a major advantage. Years of experience in the sector or industry give them an edge.
A striking example of new developments is the way in which we watch films and series or listen to music these days. The once so successful music and video stores have rapidly disappeared in favor of the exponentially growing streaming services.
In a subsequent article, we will take a closer look at the typical financial ratios that can be used to arrive at a basic selection of quality stocks.