Good, pretty and expensive: quality companies desired by investors

The dilemma is as old as the history of investing. Is it better to buy normal stocks at a low price or invest in exceptional companies even if they seem expensive? For decades the balance tilted towards the former. The legendary Warren Buffett built the foundations of his empire by buying bargains that then multiplied their trading price by 10, in a philosophy called “value investing.” However, the long period of low interest rates questioned the foundations of this theory, which was left behind, and in turn elevated the style of “quality investment”, which has ended up being the one that has given the best results in the last decade.

What are the characteristics of companies with a quality profile? The metrics that are most taken into account are: very stable income generation, low debt, wide margins, pricing capacity… sometimes the fact that they have very powerful brands or that they operate in oligopolies is also highly valued. And in what industries? There are often companies linked to the health sector, the luxury sector, very powerful industrial firms, or already consolidated technology companies… All of them, very immune to the ups and downs of the economy and politics.

One of the last references to jump fully into the philosophy of quality investment It was Jeremy Grantham, a famous British fund manager, 85 years old. This expert, founder of GMO Asset Management (120 billion dollars under management) has just registered an exchange-traded fund that will invest in this type of company. Where appropriate, it will look at those companies that “offer a high level of profitability on past investments and that use the cash flows they generate to make investments with the potential for high returns on capital or to return cash to shareholders through dividends or buybacks.” of actions”.

The good moment of quality investment can be seen in the United States Stock Market. In the last five years, the index that summarizes the evolution of this type of listed companies registered a revaluation of 96%, while the one that follows the favorite companies of the value investing it rose only 73%. In the long term, various studies suggest that the commitment to the quality profile contributes, on average, an extra 5% compared to the evolution of the market.

Terry Smith is the most famous fund manager in the United Kingdom, and one of the leading references in quality investment philosophy. In a recent interview with Five days, explained that he prefers to have only a handful of companies in his portfolio, but knowing that they have a very favorable potential for the long term. “We try to buy good companies at a good price, but the latter is secondary. The important thing is to find stocks that we can keep in the fund for many years,” he says by video call, from his golden retirement in Mauritius.

The companies that Terry Smith has in his portfolio are not exotic pearls located in Asia, but rather consolidated giants that have known how to adapt to new times. Microsoft, L’Oreal, LVMH (the parent company of Louis Vuitton), Philip Morris (owner of Marlboro cigarettes, L&M, Chesterfield…). He has also managed to incorporate some new players, such as Meta (parent of Facebook, Instagram and Whastapp, and which he has been trading for 12 years). “The important thing is that I am clear that, even if I die tomorrow, Microsoft will continue to exist for a long time,” Smith summarized.

The company founded by Bill Gates is a good example of a top quality company. Its debt level is very low, it has a presence all over the world, it has built a moat around its business that is difficult to cross (28% of computers use its operating system), in 2023 it generated a free cash flow of almost 30,000 million dollars and, to top it off, it has positioned itself very well in the artificial intelligence trend with the investment in OpenAI (the developer of ChatGPT, the most famous algorithm).

LVHM is also another company that is frequently found in the portfolios of quality managers. “It is a very well-managed company, which operates in a very resistant sector such as luxury, with very large margins, and is the owner of very consolidated brands,” explains a Spanish manager. The group controls Louis Vuitton, Givenchy, Kenzo, Marc Jacobs in the fashion world; champagne maker Moët Chandon; and jewelry companies Tiffany & Co, Bvlgari and Hublot.

Although Warren Buffett is almost always mentioned when talking about the value investing style, the truth is that the Oracle of Omaha has also been shifting his strategy towards quality companies. One of the top specialists in Spain in his figure is Pablo Martínez, head of Amiral Gestión in our country. “Buffett, through the influence of his right-hand man, Charlie Munger, realized that it is better to find quality companies that are capable of reinvesting their profits very well, rather than looking for bargains.”

One of the paradigmatic cases is that of See’s Candies, a chocolate and sweets company. Buffett bought it for $25 million in 1972 and, keeping it in his portfolio for 52 years, he has managed to collect dividends worth $1 billion. Much more recent is the bet on Apple, which has earned it some $150 billion in just six years, one of the best stock market plays in history.

From pizzas to Warhammer figurines

The Amiral firm also has its own fund with this focus, the Sextant Quality Focus, which has seen a 24% appreciation so far this year. Its manager, Vincent Mercadier, explains that in his case, they have applied an evolution to the quality management style. “We have seen that we are capable of generating extra profitability by frequently changing the weight of each of our securities in our portfolio, with a turnover that exceeds 200% annually. “This is how we take advantage of the fluctuations that any company on the stock market has.”

In this vehicle, the main positions in the portfolio are large US technology firms, such as Meta and Alphabet (parent of Google), as well as luxury companies – such as the Swiss Richmont, owners of Cartier -, and very specific bets such as British subsidiary of Domino’s Pizza or Games Workshop (manufacturer of figurines to play Warhammer). The latter “has a very loyal community of followers, and hardly any competition; In addition, it has closed agreements for some of its licenses to be converted into series,” explains Mercadier. And quality can be found in many places. From the sunny valleys of California to the shores of Lake Geneva in Geneva.

Another aspect that is always mentioned when describing this type of company is excellence in management. Look for companies whose top managers have proven a brilliant track record. It is also usually valued that there is a family nucleus in its shareholders, which guarantees that investments are made with a long-term vocation. “It is an aspect that we pay a lot of attention to,” acknowledges Beltrán de la Lastra, president of the management company Panza Capital, which manages assets worth 200 million euros.

One of the latest additions to the firm is Dassault Aviation and Thales, two French companies linked to the defense sector and in which the Dassault family has a specific weight. “They are companies with very good governance and great financial and accounting prudence. There, everything that leaves the factory has to be paid for down to the l
ast cent,” emphasizes De la Lastra. His desire is that these investments “remain in our funds for more than a decade.”

The other company they have in their portfolio in which the weight of the managers is very important is Babcock, which has maintenance contracts for nuclear submarines and frigates with the United Kingdom Army. “The David Lockwood tandem [consejero delegado] and David Mellors [director financiero] “He has shown that he has an enormous capacity to clean up and add value to a company,” says the manager of Panza Capital.

Tomás Maraver is one of the emerging stars of investment in Spain. Three years ago he launched Nartex Equity Fund, a vehicle based on the philosophy of quality investment. “It is the strategy that works best from a historical point of view,” explains the manager. “In 10 years, you can end up earning 40% more than with other strategies. One of its strengths is that in times of stock market declines the ‘quality’ falls much less than the indices.”

The Nartex project is not the only one. The manager Anta Asset Management began operating this week, with three funds that are specifically based on the quality of the assets. Federico Battaner, investment director, explains that they look “at the profitability of capital and debt ratios, they analyze the competitive advantages, such as the network effect, the brand, licenses and patents… also in the free cash flow …”.

As happened with the value investing fad, critical voices are already beginning to emerge. “Anyone who invests pays attention to the quality of the company, and anyone wants to buy at a good price,” complains one manager. Meanwhile, funds with surname quality They have become the star of the moment.

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