What does it mean to invest in high-quality companies? For us, high quality is characterised by historically stable earnings. Companies should not only be profitable when the economy is doing well. The more a company’s profits depend on the economic cycle, the more volatile its earnings and thus its share price will be. As portfolio managers, however, we are interested in the most stable earnings possible, which allow us to hold shares in our portfolio for a long time.
But how can you recognise companies with stable long-term earnings? For us, a decisive criterion is that a company benefits from structural growth trends. An ageing population that needs more medication, or helpful technologies that companies cannot do without for competitive reasons, are examples of long-term megatrends that may last for decades. Shares that benefit from such trends offer protection against economic fluctuations and more stable earnings over many years. This makes it easier to calculate sales and profit growth.
However, in view of the current high interest rates, there is another feature that we are currently paying particular attention to: corporate debt. 38% of IG corporate bonds with lower coupons mature until 2027 and must either be paid off from the balance sheet or refinanced by the companies issuing new bonds at a higher coupon. The coupon rates currently demanded by investors are higher than in previous years due to the turnaround in interest rates, thus increasing the cost of borrowing for companies. A higher debt burden weighs on profits and leaves less room for investments. In this environment, it is advisable to keep corporate debt low, as excessive debt servicing has already caused many companies to run into difficulties. We therefore exclude companies with very high debt levels from our selection.
In the case of strategic takeovers, it may make sense to use some of the debt to finance the takeover, which will increase the debt-equity ratio in the short term. A rapid reduction in debt after the consolidation of the acquired company is desirable and a very important sign of the quality of the products/services offered and of the management.
Highly successful companies are characterised by high free cash flows and a high level of liquid funds on the balance sheet. This liquidity gives companies the freedom and flexibility to take over competitors or buy back shares, while at the same time liquid funds can currently be invested at short notice at 3% to 5% (USA), thus even offering an additional source of income (interest income).
In summary, low debt means lower interest obligations and thus a lower risk of sliding into insolvency during recessions, as well as lower interest payments, which can increase profitability. Liquidity means flexibility in strategic decisions and independence from banks and other lenders. A low dependence on financing makes these companies more resilient to economic fluctuations.
