There is a wide variety of strategies that can be applied when selecting investment alternatives. Focusing on high-quality companies can be a relatively simple but very effective methodology to generate solid returns and keep portfolio risks at bounded levels.
The different investment strategies have their nuances and broad points of contact, therefore, completely objective and sharp divisions can not be made between the different methodologies that apply to the selection of assets. However, there are some differential characteristics that are more pronounced in some cases.
Growth investors, for example, often invest in highly innovative companies, with rapidly expanding sales and attractive medium-term opportunities. Value investors, on the other hand, often position themselves in assets that they consider to be undervalued due to excessive market pessimism.
The central factor to take into account in quality investments is the strength and strength of the business from the fundamental point of view. What quality investors look for is to be sure that the company will be able to continue increasing its sales and profits in the long term, that is, that the value of the asset will increase over time.
The quality of a company must be analyzed from different angles, not only based on the financial variables and the financial statements of the company, but also taking into account qualitative aspects that make the solidity of the business and its management team.
Regarding the qualitative characteristics of the business, it is vital that it has strong competitive advantages, that is, tools to protect itself from competition. Competitive advantages can be based on scale factors, a differentiated brand or patents on different technologies, for example. In fact, it is common for high quality companies to combine different kinds of competitive advantages at the same time.
The suitability of the company’s management team is another important variable to consider. In general, it is desirable to have executives who have a long track record of success in the company, this guarantees that they know the culture and strategic direction of it, thus avoiding abrupt or unexpected changes of direction.
It is important to bear in mind that these factors are reflected in the return of long-term assets, that is, over the years. Therefore, quality investors usually have a patient attitude and a strategic mindset when it comes to managing their positions.
It could be said that the quality investor makes his purchasing decisions based on considerations similar to those that could be taken into account to invest in a real business, unlike the short and medium term operations that are often the most common in the stock market.
High-quality companies tend to operate in low-risk sectors such as health, public services or consumption. In general, these are companies of considerable size, with a high market share and a healthy degree of diversification, both geographically and in terms of their product portfolio. This kind of actions, then, are less vulnerable to the possible effects of a recession or an economic crisis.
Financial solvency is a key variable to take into account when analyzing the quality of a company. In this sense, it is essential that the company presents moderate levels of debt.
In addition, it is important that the firm has a good track record of generating cash flows to ensure its solvency, it is illustrative to analyze the evolution of cash flows in periods of economic complications to assess the strength of the firm in these scenarios.
High quality stocks also tend to have a good record of dividend payments and share repurchasing, which shows that the profits are transparent and that the business generates enough cash to finance its operations and also distribute funds to its shareholders.
High profit margins are also often a common feature of these businesses, as they usually have the ability to sustain profits despite possible cost increases or product price drops.
Quality investments are not generally those that provide the most explosive returns in the short term, however, their stability is highly valued during periods of volatility in the markets.
In addition, given that the investor has a high degree of confidence in the strength of the business, periods of falling prices are often interpreted as buying opportunities to increase positions at more convenient prices, and this helps maximize long-term profits term.