What You Need to Know

High-quality companies are always in style. In good times and bad, features that define resilient businesses and stocks underpin consistent and solid equity return potential. But to consistently find companies that meet the highest quality standards requires research, judgment and investing skill. In this paper, we identify the characteristics that can help guide investors to high-quality businesses, and present different investment approaches designed to capture these companies in equity portfolios.

S&P 500 Quality annualized returns

1994–2020

Outperformance of S&P Quality vs. S&P 500 in coronavirus downturn

Feb 2020–Mar 2020

US companies with >=10% YoY Earnings Growth

Annualized excess returns vs. S&P 500
1979–2019




The hunt for quality allows investors to tap equity return potential with smoother return patterns. Quality stocks with the right attributes tend to offer superior risk-adjusted returns, posting solid gains in rising markets and cushioning investors in a downturn. Over time, stocks with these characteristics have outperformed cap-weighted benchmarks, while also protecting capital during events as varied as the bursting of the technology bubble, the global financial crisis and the new coronavirus pandemic ( Display).

For more than a quarter of a century, the S&P 500 Quality has outperformed the broader market with less risk. But to position properly in crisis periods, quality control is crucial. Investors who concentrate on quality in their everyday stock-picking processes are better equipped to identify durable companies that have what it takes to get through uncertain times. And by holding stocks that tend to fall less than the market in a downturn, it’s easier for a portfolio to recoup losses quickly and outperform in a future rebound.

WHAT DISTINGUISHES TRUE QUALITY?

Capturing the superior risk-adjusted returns that quality stocks offer requires a forward-looking approach and identifying the right measures to pursue. We believe that sturdy balance sheets, high and stable profits and strong free cash flows are good ways to identify companies with the ability to withstand a recession and thrive when conditions improve.

Passive approaches use various measures to define quality, but they’re backward looking. This presents a severe flaw in systemic crises, particularly the COVID-19 pandemic, in which the future will look nothing like the past. For example, companies that scored high on quality measures such as earnings growth and profitability in the past might not continue to perform well in the coronavirus recession, as rampant demand destruction unfolds in unpredictable ways.

THREE INTERCONNECTED FEATURES

To find quality today, investors need a discerning view of a company’s underlying dynamics. By studying industry conditions, demand drivers and company business models, investors can assess quality using these three lenses:

  • High and Stable Profitability—This is usually a sign that a company has a differentiated and durable business, with a better chance of survival through a recession.
  • Strong Free Cash Flow—Good businesses generate excess cash, the lifeblood of economic activity, especially in a crisis when businesses are squeezed. This gives companies more financial flexibility to enhance shareholder returns.
  • Healthy Balance Sheets—Companies with ample cash and low debt levels have a healthier foundation to invest for the future and execute strategy without being subject to the moods of capital markets. They’re also better positioned to withstand challenging conditions.

The three characteristics above are interconnected. Companies that generate consistent free cash flows are in a better position to cover debt-servicing costs—even when there’s less cash to keep the business afloat. And low earnings volatility is a good indicator of a company’s ability to perform through complex and changing business conditions.

Past performance, historical and current analyses, and expectations do not guarantee future results. There can be no assurance that any investment objectives will be achieved. The information contained here reflects the views of AllianceBernstein L.P. or its affiliates and sources it believes are reliable as of the date of this publication. AllianceBernstein L.P. makes no representations or warranties concerning the accuracy of any data. There is no guarantee that any projection, forecast or opinion in this material will be realized. Past performance does not guarantee future results. The views expressed here may change at any time after the date of this publication. This document is for informational purposes only and does not constitute investment advice. AllianceBernstein L.P. does not provide tax, legal or accounting advice. It does not take an investor’s personal investment objectives or financial situation into account; investors should discuss their individual circumstances with appropriate professionals before making any decisions. This information should not be construed as sales or marketing material or an offer or solicitation for the purchase or sale of any financial instrument, product or service sponsored by AB or its affiliates.

The views expressed herein do not constitute research, investment advice, or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.

MSCI makes no express or implied warranties or representations, and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed or produced by MSCI.

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