Time to invest in top quality stocks
Smart investors that have been busy picking top quality stocks have been reaping the rewards for their hard work. At the top of their target list, has been that top quality company that has no debts or has been reining in their debts. Privately, clever investors always do opposite what they say in public. They tend to shy away from saying what their true intention is, when they want to invest.
Those smart investors have targeted companies that are reducing debts or stopping completely from taking any debts on their balance sheet and at the same time focusing on growing their top line sales. Their share price outperformance over the past few years has been proven the point. Very low interest rates environment have encouraged those companies to clean up their balance sheet in a way that helped them focusing on growing top line sales and increasing bottom line profits. This should be borne in mind when looking at surveys of investors’ opinion.
It is one of the best and the oldest principle of equity investment that says, good quality stocks should do will in the long term for loyal investors. There are no shortages of those top quality stocks. The problem for investors is to find them and making sure that they meet strict investment criteria’s that demands good performances. This investment principle should at all times apply to value or growth stocks. Investors should not compromise for the sake of short-term gains.
Recent investors worry about the slowing economic growth in China and their concerns about those companies that have expanded in China through leverage have indeed happened. Investors do not mind if companies are expanding into the world’s second biggest growing economy. However, they demand that those companies to be extra conservative taking into account the worries about the macro situation, and particularly in China.
Pension plan
Equity investors no longer believe that companies’ balance sheets are underleveraged, and the proportion that wants companies to repay debt or top up their long term liabilities such as pension plans, slightly exceeds the proportion wanting cash to be returned to shareholders, via buybacks, dividends or cash mergers. This is the first time this has been so since for a long time. It seems that investors no longer reward companies that pay higher dividends and do share buybacks. As I said earlier, investors are demanding top line earnings growth but also an increase in the bottom line too. We have noticed the evidence of this in the past few weeks. Some companies that have missed earnings by a small margin and delivered smaller profits were sold off aggressively even though they increased dividends and announced share buybacks.
In the past few months’ international companies have been writing down debts quite drastically. I expect these big write-downs to be a warning ahead for lower sales and earnings. Sectors that are related to consumer staples, utilities, energy and oil and above all those in the mining industry are expected to suffer earnings declines. In such circumstances, companies are expected to beat guidance significantly, and debt-funded share buybacks will not counteract falling revenues. Again, for equity investors this will either cause confusion or give them a big headache. For investors the options are limited. For those investors that have to be long in equities, staying with top quality stocks appears to be a very good and sound idea. Top quality stocks lead most of the recent bounces back in the global equity indices. I expect there is more room for those quality stocks to continue outperforming.
Overall quality indices have started to outperform after a long period of mediocre or poor performance. In this environment, investors need to do a lot of their own due diligence - perhaps an unusual feeling after years of stocks being driven by falling interest rates and currency devaluations.
— Rasameel Restructured Finance Company