There are several rational reasons for the over performance of quality companies in a declining market. Investing in quality companies could be described, for example, as \u201cbuying excellent companies at a reasonable price.\u201d<\/strong> Several studies have shown that quality stocks have outperformed the market in the long run with lower than average volatility.<\/p>\n\n\n\n Steadily growing companies, high ratio of recurring revenue, customer-critical products and good profitability, will be further strengthened during a downturn.<\/p><\/blockquote>\n\n\n\n Good profitability is one of the hallmarks of a quality company.<\/p>\n\n\n\n How to analyze a company\u2019s short- and long-term financial profitability?<\/strong> Let\u2019s look at this using the investment criteria for quality companies in the Sifter Fund.<\/p>\n\n\n\n <\/p>\n\n\n\n The table compares the key business indicators (KPIs) of the Sifter Fund and the S&P 500 index companies. The Sifter fund companies’ Return on Invested Capital (ROIC), operating profit, revenue growth and net debt are better than those of the S&P 500 companies.<\/p>\n\n\n\n The identification of a quality company is first based on solid numerical data, which make it clear that the company has already demonstrated superior financial ability historically. Key numerical selection criteria include:<\/p>\n\n\n\n Investing is very much about estimating a company\u2019s future growth and profits<\/strong>. Therefore, predictability of growing sales is important for a quality investor. Steady revenue reflects customers\u2019 preferences and loyalty. <\/p>\n\n\n\n An increasing operating profit reflects a company\u2019s efficiency and ability to generate money. The predictability of positive cash flows, in turn, brings peace of mind to the shareholder.<\/p>\n\n\n\n High gross margins indicate that the company’s products and services have pricing power<\/strong> i.e. customers are willing to pay a premium. A high gross margin gives the company room to maneuver in price competition and the ability to pass on inflationary pressures to product prices. <\/p>\n\n\n\n Correspondingly, high net margins indicate a company’s efficiency in manufacturing and selling products, creating more value for the owners and investors.<\/p>\n\n\n\n Among other things, a<\/strong> high ROIC indicates that the company’s management is consistently finding good investment targets to develop and grow its own business<\/strong>. A high ROIC generally promises future profits as well. <\/p>\n\n\n\n We like companies that invest in business growth rather than distributing profits as dividends to shareholders.<\/p>\n\n\n\n We like companies that are able to grow their business without large debts. A strong balance sheet is especially important when shocks occur in the market that may make capital less available and more expensive<\/strong>. <\/p>\n\n\n\n In addition, we want our companies\u2019 balance sheets to be clean, meaning they do not include large items, such as goodwill.<\/p>\n\n\n\nWhat does a quality portfolio look like in terms of KPIs?<\/h2>\n\n\n\n
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Numerical selection criteria tell the history of the company<\/strong><\/h2>\n\n\n\n
1. Sales and operating profit have grown steadily and are predictable<\/h3>\n\n\n\n
2. Higher gross and net margins than competitors<\/h3>\n\n\n\n
3. High Return on invested Capital (ROIC)<\/strong><\/h3>\n\n\n\n
4. A solid balance sheet, preferably a net debt-free company<\/h3>\n\n\n\n