What are we looking for?
Forget the fuss over whether you should pursue a growth strategy or a value strategy in your investment portfolio. In the aftermath of the Great Recession, says Brockhouse Cooper global macro strategist Pierre Lapointe, both strategies are being trumped by “quality” – stocks that deliver high return on equity, low volatility and clean balance sheets.
Mr. Lapointe says that the best returns over the past three years have had little correlation to stock price-to-earnings valuations (the value approach) or to earnings growth expectations (the growth approach). Rather, the top-quality stocks – regardless of whether they fit the growth or value mould – have substantially outperformed the MSCI U.S. Growth and MSCI U.S. Value indexes.
Today, with Mr. Lapointe’s help, we go in search of the highest-quality stocks on the S&P 500.
The quality screen
Mr. Lapointe devised a screen for stock quality that centres on return on equity (ROE) – annual net income expressed as a percentage of total shareholder equity. It essentially measures the size of profits relative to the size of the total investment in the company – a good way of seeing how much bang investors get for their bucks.
He screened for S&P 500 stocks with ROEs of more than 15 per cent. He also used ROEs to screen for low volatility – requiring that each stock have a six-year variation of ROE of less than 10 per cent. The screen also required that each stock have a debt-to-common-equity ratio of less than 50 per cent. Mr. Lapointe’s screen generated 72 stocks on the S&P 500 that met all three high-quality criteria.
In our slight variation on that screen that we present here, we’ve taken only the 25 stocks with the highest ROEs – making our ROE cut-off just below 24 per cent.
What we found
The highest-quality stocks generated in the Brockhouse Cooper screen are dominated by two sectors: Information technology and consumer discretionary. We’re not sure exactly what that tells us about the nature of these sectors or the current economic cycle, but clearly the sectors have some names with a knack for big, stable profits and little problem with over-leveraging.
Topping the list is technology- and management-consulting firm Accenture PLC. The eye-popping 71.5-per-cent ROE is hard to ignore in itself, but the fact that it generates such strong ROEs consistently, and has little debt exposure, makes it a winner using Mr. Lapointe’s criteria.