As the market grows increasingly turbulent and economic outlooks become more cautious, investors are increasingly buying quality stocks, which by definition are stocks whose companies are not overly reliant on a robust economy for their performance. Their quality comes from their underlying companies having a sturdy, dependable business, high and consistent profits, and a strong balance sheet free of burdensome amounts of debt. In the current environment, Walmart Inc. (WMT), McDonald’s Corp. (MCD), Pfizer Inc. (PFE), Procter & Gamble Co. (PG) and Amgen Inc. (AMGN) have all received the quality stamp of approval by Citigroup, according to CNBC.
5 Quality Stocks that Outperform
|Procter & Gamble||+ 0.2%|
|S&P 500||– 1.2%|
Source: CNN Money, as of 4pm EST 11/20
All these stocks, save for Walmart, have outperformed the S&P 500 this year, suggesting a clear investor preference for high quality stocks over most of the rest of what the market has to offer in these more volatile times.
What It Means
The flight to quality is a warning sign that the economy may be reaching the later stages of its current cycle, but at the same time, it also demonstrates how investors are protecting themselves if and when the economy eventually shifts into recession territory. In the event of a downturn, highly cyclical companies will be under strain as demand for their goods and/or services wanes. The weakest among them will likely be those with heavy debt loads, which have already become more burdensome as interest rates have risen, but will become even more so in a downturn as revenue growth declines and possibly turns negative.
Blue chip companies, on the other hand, are more likely to weather the downturn, as their well-established products and services are less affected by economic cycles. Their resilient profitability helps them to maintain strong balance sheets, which in turn leads to better debt ratings, which in turn leads to earning a label like ‘quality’ from market analysts.
For the first time in nearly two decades, quality stocks now trade at a valuation premium to low-quality ones, according to Bank of America Merrill Lynch.
Among the five quality stocks mentioned above, biotechnology firm Amgen could see its stock hit $220 in the near future—a 12% gain—as new product releases hit the market. The company has all the quality indicators: an established brand, dependable drug products, a consistent history of paying out earnings, and strong cash flow that has left the company’s balance sheet with more cash than debt.
In addition to Citi’s picks, Goldman Sachs recently gave their recommendation for high-quality stocks that are likely to outperform in a downturn, including BlackRock Inc. (BLK), PNC Financial Services Group Inc. (PNC), Aflac Inc. (AFL), Oracle Corp. (ORCL), Apple Inc. (AAPL), CVS Health Corp. (CVS), IDEXX Laboratories Inc. (IDXX), and Church & Dwight Co. Inc. (CHD). Goldman considers such stocks to be high quality because they have a limited history of big price declines and their respective companies maintain strong balance sheets, stable revenue and profit growth, and have high ROEs.
To be sure, these are longer-term recommendations as a full-on bear market will likely even drag them down to some degree, albeit less than the rest of the market. But given their strong balance sheets and non-cyclical businesses, they should be able to weather the storm and come out ahead of the rest.