"Own only high-quality stocks" is one of those investment maxims that always sounds smart but only sometimes works well.
This seems to be one of those times.
Shares of quality companies have been outperforming the broad benchmarks — both before the October market correction and on the bounce of the past two weeks.
As a characteristic of companies — a "style factor" for selecting stocks, in the industry jargon — quality has no single, strict definition. But the common traits are a sturdy business not reliant on a strong economy; high and resilient profitability; and a strong balance sheet unburdened by much debt.
There are several exchange-traded funds built to isolate quality stocks, such as the Invesco S&P 500 Quality (SPHQ), which selects S&P 500 stocks highly ranked by return on equity, better-quality cash earnings and low financial leverage. It captures a lot of stable growth companies, with 35 percent of the fund in tech, 15 percent consumer staples and only token helpings of energy and financials.
This ETF started outperforming the S&P 500 a few months ago, and since August has led by 1 percentage point.
Goldman Sachs' equity strategy group maintains stock baskets filtered for quality and strong balance sheets, which also have performed well, with the quality strategy soaring relative to the market lately.
Many professional investors have been calling for some time for a rotation from expensive growth stocks to cheaper value stocks. But quality, as an attribute, isn't the same as value; the value indexes are full of highly cyclical, heavily indebted boom-bust companies.
Quality has a lot more overlap with defensive stocks. Health care is the best-performing sector in the S&P 500 this year, up more than 12 percent and is among the groups most heavily weighted in quality companies.