Tilo Wannow, ODDO BHF Asset Management.
Capital markets have undergone a complete turnaround. At the beginning of the year, US equities were in demand, but with the inauguration of Donald Trump, market sentiment shifted radically in the other direction and European equities, which had previously been spurned, soared.
As unpredictability has become Donald Trump’s trademark, volatility is likely to continue. In such a volatile market environment, it is less important for investors to move in and out of positions quickly and more important to focus on quality stocks that can withstand turbulent times. Such stocks can be held even when stock markets are falling.
We define quality stocks as high-growth, low-risk companies. We focus strongly on the fundamental prospects of individual companies. In the current environment, resilience to economic or external shocks is particularly important. In addition, we believe that quality stocks have structural earnings growth, i.e. the markets in which quality companies operate grow independently of a strong economy.
Characteristics and advantages of quality stocks
A key characteristic of quality companies is that they are less dependent on economic trends. They offer products or services that are in demand even in difficult economic times. This enables them to generate stable and growing profits over long periods. This steady profit growth is often based on a strong market position, which enables companies to enforce their prices and secure sustainable competitive advantages. Recurring revenue streams, such as subscriptions or long-term contracts, also contribute to financial stability.
In particular, companies with a diversified product range benefit from being less vulnerable to fluctuations in demand. While manufacturers of consumer staples or personal care products remain stable during economic downturns, manufacturers of high-priced industrial products often suffer significant declines in sales during such periods.
Another key characteristic of quality companies is their solid financial base. A healthy balance sheet structure and low debt levels help them to weather economic downturns and interest rate hikes better. Companies with low-interest rate sensitivity have to raise less capital for interest payments and benefit from greater financial flexibility, especially in times of rising interest rates.
High liquidity reserves also enable continuous investment in research, development or strategic growth areas that create long-term value and help to sustainably strengthen the market position. In times of economic crisis, fixed costs often remain, while operating profits fall disproportionately to the decline in sales. Companies with an efficient cost structure and high operating profit margins are better able to cushion such fluctuations.
In addition to financial stability, long-term market position plays a crucial role. Quality companies benefit from established market positions and sustainable competitive advantages, which enable them to plan their business development with a high degree of certainty. Customer loyalty is particularly strong in companies with closed ecosystems. VISA and Microsoft have spent years developing complex, coordinated product and service offerings.
Such ecosystems offer customers high levels of value and make it much harder to switch to competing products. Many of these companies also benefit from strong network effects, as a growing user base exponentially increases the value of their products. In particular, digital payment service providers or software vendors reinforce this effect by increasing their attractiveness to other customers and business partners with each additional user.
At the same time, high switching costs create significant barriers to switching providers, as customers are already integrated into established systems or specific applications. This leads to long-term contractual relationships, stable revenue streams and stable margins.
In summary, quality equities have a very positive long-term outlook: structurally rising earnings with a relatively low risk of major setbacks. In a volatile market environment, these are not bad prospects.
