Good, beautiful and expensive: quality companies in demand by investors | Financial markets

This dilemma is as old as the history of investing. Is it better to buy common stocks at low prices or invest in exceptional companies even if they seem expensive? For decades, the balance has tipped towards the former. The legendary Warren Buffett laid the foundations of his empire by making trades that then multiplied their trading price by 10, in a philosophy called “value investing.” However, …

This dilemma is as old as the history of investing. Is it better to buy common stocks at low prices or invest in exceptional companies even if they seem expensive? For decades, the balance has tipped towards the former. The legendary Warren Buffett laid the foundations of his empire by making trades that then multiplied their trading price by 10, in a philosophy called “value investing.” However, a prolonged period of low interest rates challenged the foundations of this theory, which was left behind, and in turn raised the “quality investing” style, which ultimately delivered the best results in the last decade. .

What are the characteristics of companies with a quality profile? The metrics that count most are: very stable revenue generation, low debt, wide margins, pricing power… sometimes the fact that they have very powerful brands or that they operate in oligopolies is also highly valued. And in what industries? There are often companies associated with the healthcare sector, the luxury sector, very powerful industrial firms or already consolidated technology companies… All of them are very immune to the ups and downs of economics and politics.

One of the last links to fully immerse yourself in philosophy quality investments It was Jeremy Grantham, a famous British fund manager, 85 years old. This expert, the founder of GMO Asset Management ($120 billion under management), has just registered an exchange-traded fund that will invest in these types of companies. Where possible, it will consider those companies that “offer a high level of return on past investments and use the cash flows they generate to make investments with the potential for high returns on capital or to return cash to shareholders through dividends or buybacks. “actions”.

A good moment for quality investments can be seen in the US stock market. Over the past five years, an index that summarizes the evolution of listed companies of this type has registered a 96% revaluation, while an index that follows favorite companies value investing it grew by only 73%. In the long term, various studies show that adherence to a quality profile gives on average an additional 5% compared to market development.

Terry Smith is the UK’s most renowned fund manager and one of the leading authorities on the philosophy of quality investing. In a recent interview with Five days, explained that he prefers to have only a few companies in his portfolio, but knows that they have very favorable potential in the long term. “We try to buy good companies at a good price, but the latter is secondary. It’s important to find stocks that we can hold in the fund for many years,” he says via video call after his golden retirement in Mauritius.

The companies in Terry Smith’s portfolio are not exotic gems located in Asia, but consolidated giants that can adapt to new times. Microsoft, L’Oreal, LVMH (parent company of Louis Vuitton), Philip Morris (owner of Marlboro, L&M, Chesterfield cigarettes…). It has also managed to attract some new players such as Meta (the parent company of Facebook, Instagram and WhatsApp, which has been trading for 12 years). “The important thing is that I am clear that even if I died tomorrow, Microsoft will continue to exist for a long time,” Smith concluded.

The company founded by Bill Gates is a good example of a top quality company. Its debt levels are very low, it has a global presence, it has built a moat around its business that is hard to cross (28% of computers use its operating system), it generated free cash flow of almost $30,000 million in 2023, and, to top it all off, it positions itself very well in the artificial intelligence trend thanks to its investment in OpenAI (developer of ChatGPT, the most famous algorithm).

LVHM is another company that can often be found in the portfolio of quality managers. “It is a very well-managed company that operates in a very stable sector such as luxury, with very large profits and is the owner of very consolidated brands,” explains the Spanish manager. The group controls Louis Vuitton, Givenchy, Kenzo, Marc Jacobs in the fashion world; champagne producer Moët Chandon; and jewelry companies Tiffany & Co, Bvlgari and Hublot.

While Warren Buffett is almost always mentioned when talking about value investing style, the truth is that the Oracle of Omaha is also shifting its strategy toward quality companies. One of Spain’s leading experts in this regard is Pablo Martinez, head of Amiral Gestión in our country. “Buffett, through the influence of his right-hand man, Charlie Munger, realized that it is better to find quality companies that can reinvest their profits very well, rather than look for bargains.”

One case in point is the story of See’s Candies, a chocolate and candy company. Buffett bought it for $25 million in 1972 and, holding it in his portfolio for 52 years, managed to collect $1 billion in dividends. A much more recent bet on Apple, which earned about $150 billion in just six years, became one of the best stock market games in history.

From pizza to Warhammer figures

Amiral also has its own fund dedicated to this area, Sextant Quality Focus, which is up 24% this year. Its manager, Vincent Mercadier, explains that in his case they applied an evolution of the quality management style. “We saw that we were able to generate incremental returns by frequently reweighting each of our securities in our portfolio, with turnover in excess of 200% per year. “That’s how we capitalize on the fluctuations that any company has in the stock market.”

In this arrangement, major portfolio positions are occupied by large US tech firms such as Meta and Alphabet (parent company of Google), as well as luxury companies such as Switzerland’s Richmont, which owns Cartier, and very specific bets such as the UK subsidiary of Domino’s Pizza or Games Workshop (manufacturer of Warhammer figures). The latter “has a very loyal community of followers and virtually no competition; In addition, it has entered into agreements to convert some of its licenses into serial ones,” explains Mercadier. And quality can be found in many places. From the sunny valleys of California to the shores of Lake Geneva in Geneva.

Another aspect that is always mentioned when describing companies of this type is excellent management. Look for companies whose top managers have a proven track record. It is also generally appreciated that there is a family unit among the shareholders, which ensures that investments are made for the long term. “This is an aspect that we pay great attention to,” admits Beltrán de la Lastra, president of asset manager Panza Capital, which manages €200 million in assets.

Some of the latest additions to the firm are Dassault Aviation and Thales, two French companies with ties to the defense sector in which the Dassault family holds particular weight. “These are companies with very good management and great financial and accounting prudence. There, you have to pay for everything that comes out of the factory to the last cent,” De la Lastra emphasizes. His wish is for these investments to “remain in our funds for more than ten years.”

Another company in their portfolio where management weight is very important is Babcock, which has maintenance contracts for nuclear submarines and frigates with the UK Army. “The tandem of David Lockwood (CEO) and David Mellors (CFO) has shown that they have enormous potential to turn things around and add value to the company,” says Panza Capital manager.

Tomas Maraver is one of Spain’s young investment stars. Three years ago, he launched Nartex Equity Fund, a vehicle based on the philosophy of quality investing. “This strategy works best from a historical perspective,” explains the manager. “In 10 years, you can earn 40% more than using other strategies. One of its strengths is that during stock market downturns, “quality” falls much less than the indexes.”

The Nartex project is not the only one. Anta Asset Management launched this week with three funds that specifically focus on asset quality. Federico Battaner, chief investment officer, explains that they look “at the return on equity to debt ratio, analyze competitive advantages such as network effects, brand, licenses and patents… as well as free cash flow…”.

As with the value investing craze, critical voices are already beginning to emerge. “Anyone who invests looks at the quality of the company, and everyone wants to buy at a good price,” complains one manager. Meanwhile, funds with the surname quality They became the star of the moment.

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