‘Free lunch’: Forget growth or value, Wilsons is hunting these ASX shares

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Growth shares have been hammered this year after investors turned their backs on them due to rising interest rates.

But for a decade before that, growth ruled over value stocks.

So what style of ASX shares are the best going forward from now?

Perhaps fittingly for unprecedented conditions like we’re seeing in 2022, Wilsons head of investment strategy David Cassidy has nominated a third way to go.

“Quality-focussed investment strategies arguably receive less attention than growth and value investing, yet the quality factor has an impressive long-term track record,” he said in a memo to clients.

“The outlook for quality is particularly attractive at the current juncture in the global business cycle.”

What is quality?

Cassidy expects the global economy and earnings growth to “slow significantly” over the next 12 months.

“As a result, companies with high quality, resilient earnings streams should be increasingly sought after by the market.”

But what exactly makes a stock or a company “quality”?

There is no universal definition of what a quality stock is, but Cassidy mentioned a few quantifiable attributes that most investors would find hard to argue against:

  • High return on equity or return on invested capital
  • Resilient earnings streams
  • Strong balance sheets with modest level of debt

On top of this, he added, more active investors can consider these more subjective qualities:

  • Management quality
  • Industry positioning

Cassidy said a high quality business typically has a wide moat, which is a measure of competitive advantage.

“These competitive strengths can include: superior product or service quality, a strong brand, superior scalability, distribution strength, or proprietary technology.”

How does quality investing work in real life?

“Highly active” investors with a quality strategy will often exclude entire sectors. For example, mining and financials might be completely ignored due to the earnings volatility.

Quality shares often display a “risk asymmetry”, as Cassidy calls it.

“This risk asymmetry, with decent performance in rising markets but superior performance in falling or sluggish markets, that gives quality its outperformance trend over the long-term.”

He added that there is “a large body” of academic research that shows low volatility and high quality portfolios outperform their high volatility and low quality rivals. 

“This perhaps flies in the face of traditional portfolio theory, which holds that higher risk portfolios will generate higher returns in the long run.”

‘Free lunch’ for investors

So with so much going for it, Cassidy said buying up quality shares might be considered a “free lunch” for investors of ASX shares.

But the catch is that the outperformance only comes over a long duration.

In fact, quality has actually underperformed over the past two years.

“The growth stock rally entered a speculative phase last year with many high-growth (pre-earnings) stocks being bid up aggressively. More recently, a big first quarter commodity rally, led by energy in particular, saw quality indices lag again.”

But in 2022 high-growth stocks have definitely been humbled and commodity prices are starting to cool.

“Quality has begun to show signs of outperformance. With earnings slower and downgrades increasing, resilient high-quality companies look set to outperform in our view.”

The post ‘Free lunch’: Forget growth or value, Wilsons is hunting these ASX shares appeared first on The Motley Fool Australia.

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Motley Fool contributor Tony Yoo has no position in any of the stocks mentioned. The Motley Fool Australia’s parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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