It's Time for Quality to Shine

When it comes to the various investment factors, it's often said that there's never a bad time to embrace quality for the simple reason that quality stocks offer superior risk-adjusted returns over their low- and no quality counterparts over the long haul.

However, quality isn't perfect all the time. Through a rough start to 2021, the S&P 500 Quality Index is barely outperforming the S&P 500. Both are off more than 10%. Thing about quality is it's fluid compared to other factors. For example, growth and value are straight-forward and how index providers interpret those factors doesn't differ all that much.

Conversely, there are myriad ways to skin the quality cat. One of the sturdy ways of doing so is to focus on shareholder rewards, including buybacks and dividends. As advisors know, dividend growth is all the more important today due to low interest rates and inflation. Additionally, data support the fact that payouts are in fact growing.

“US companies in our index distributed a record $522.7bn in 2021, up 5.9% on an underlying basis, equivalent to a headline rise of 3.5%. The steady increase follows a relatively muted impact in 2020 from the pandemic,” according to the latest reading of the Janus Henderson Global Dividend Index.

When Quality Equals Royalty

There are other elements of the quality equation savvy clients are sure to like, including the ability to sustain and grow payouts as well as, in many cases, durable competitive advantages (wide moats).

“Dividend growth strategies, like the S&P 500® Dividend Aristocrats®, embody this quality approach. The Dividend Aristocrats indexes are groups of companies, with versions across several different market-cap spectrums, that have sustained records of continuous dividend growth,” says ProShares Senior Investment Strategist Kieran Kirwan.

A couple of more things to consider. First, quality stocks are distinct from low volatility fare, but the former often exhibits traits of the latter. Second, one of the hallmarks of quality, regardless of how it's being defined, is steady management.

“Regardless of the macroeconomic circumstances, management at these elite firms reliably sends a powerful signal to the market, in the form of growing dividends, that they have confidence in their underlying business prospects,” adds Kirwan. “That they believe revenues and earnings will remain resilient, and that cash flow to support a growing dividend will continue.”

Quality and Versatility

An often overlooked part of the dividend and quality conversations is that when these styles are combined, they're applicable (and accessible) across the three major market capitalization spectrums. That comes with the advantages of reduced volatility and less downside capture.

“Through February, the large-cap S&P 500 Dividend Aristocrats Index has captured 82% of the S&P 500’s downside. Mid- and small-cap dividend growers have done even better,” concludes Kirwan. “The S&P MidCap 400 Dividend Aristocrats Index has captured only 50% of the S&P MidCap 400’s losses, while the Russell 2000® Dividend Growth Index has captured only 39% of the Russell 2000 Index’s losses.”

Bottom line: With dividend growth ascending to records, bond yields low, inflation high and quality all the more meaningful, advisors have good reason to make quality a conversation starter with clients today.

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