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Number Cruncher

Hunt is on for quality stocks with stable profitability Add to ...

What are we looking for?

In highly volatile and risky markets, investors are increasingly focusing on quality. Which stocks offer consistently superior returns? Which are less exposed to the unpredictable credit markets? Which are least susceptible to volatile swings in profits?

Toward that end, we look at global high quality stocks with stable profits – courtesy of the Montreal-based research team at Brockhouse Cooper.

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Quality and stability

Global macro strategist Pierre Lapointe and financial economist Alex Bellefleur said “quality” companies are typically characterized by a combination of high profits and low debt. They screened the S&P Global 1200 index of worldwide stocks for the highest-quality names, using three criteria: Return on equity (ROE) of more than 15 per cent; stable profitability (a six-year “ROE coefficient of variation” – a measure of stability – of less than 25 per cent); and a debt-to-equity ratio of less than 80 per cent.

“The tech bubble led investors to prefer higher-quality stocks,” they wrote in a recent report. “With the exception of the 2007-09 bear market, quality stocks have consistently traded at higher valuations than lower-quality ones.”

They found 137 stocks – 11 per cent of the index – met all three criteria. Mr. Lapointe and Mr. Bellefleur sorted their screen results by profit stability (the ROE coefficient of variation) – highlighting what they consider to be the critical concern right now for investors in search of quality.

“As long as the latest recession will remain fresh in investors’ minds, concerns over profit volatility will keep pressure on valuations,” they wrote. “We believe that investors will continue to pay a premium for higher-quality stocks, especially the ones with low profit volatility.”

What did we find?

One of the top names on this global list of high-quality stocks is a Canadian one – supermarket chain Metro Inc. It’s the only Canadian name on the list, but not the lone grocery-store operator – evidence that traditionally defensive consumer staples do, indeed, offer profit stability and lower-risk businesses in bad times and good.

Mr. Lapointe and Mr. Bellefleur point out the high-quality names on global markets are trading at a premium to lower-quality names: The trailing-12-month price-to-earnings multiple for the high-quality names is 15.6, compared with 12.0 for the overall global index. However, they don’t believe that implies that high-quality stocks are expensive.

“In our opinion, because investors have been burned twice in the past decade, a premium for quality is the new reality.”

 
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