Stocks are rebounding to start 2023, but markets are still in fragile spots, underscoring the notion that quality remains pivotal. Admittedly, the quality thesis could be tested by large-cap technology stocks, but the fact remains relevant today.
One of the reasons quality is prized is durability. Sure, the S&P 500 Quality Index is trailing the parent benchmark year-to-date, but quality has long-term chops. For example, the S&P 500 Quality Index topped the standard S&P 500 over the past three years. For the 10 years ending, 2022, the S&P 500 Quality Index beat the parent gauge 1,120 basis points while sporting less annualized volatility.
That’s good news, but if there’s a knock on quality, it’s that there’s a lack of uniformity in defining it. That said, there are some frequently cited pillars, including shareholder rewards, steady management, profitability and favorable debt metrics, among others. Additionally, a company’s financial statements hold quality clues.
“The income statement, balance sheet, and statement of cash flows are required financial statements. These three statements are informative tools that traders can use to analyze a company's financial strength and provide a quick picture of a company's financial health and underlying value,” according to Charles Schwab.
Searching for Quality? Bet on the Balance Sheet.
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.
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.
Advisors looking for clues as to how to locate quality can easily find some guidance on balance sheets, which often act as roadmaps to or away from quality.
“While the income statement is a record of the funds flowing in and out of a company over a given time period, the consolidated balance sheet is a snapshot of a company's financial position at a given point in time. In other words, the balance sheet shows what a company owns (its assets) and owes (its liabilities) and the difference between the two (stockholders' equity). This difference represents the book value of the stockholders' stake in the company. It's called a balance sheet because both sides of the equation must balance: assets equal liabilities plus stockholders' equity,” adds Schwab.
Quality Right Recipe for This Environment
With inflation persisting, earnings growth slowing and the possibility of a material economic slowdown lurking, quality could be a pivotal piece of the 2023 investing lexicon and one that shouldn’t be ignored.
Further enhancing the allure of a focus on quality is the point that valuations are attractive on some prime quality destination, such as healthcare and technology, confirming the cost of admission for quality is more than reasonable today.