I wish I’d known about this lucrative style of stock market investing 20 years ago
Middle-aged white man wearing glasses, staring into space over the top of his laptop in a coffee shop
I’ve been investing in the stock market for over 20 years now. And in this time, I’ve experimented with a range of different styles including small-cap investing and dividend investing.
In recent years however, I’ve mainly been pursuing an approach known as ‘quality’ investing – a style that tends to deliver excellent long-term returns. I only wish I’d known about this style of investing 20 years ago.
How quality investing works
Quality investing is, at its core, a relatively straightforward strategy. The goal is simply to invest in high-quality businesses at reasonable valuations.
Of course, the term ‘high-quality’ means different things to different people. But here, it generally means companies that:
- Have wide ‘economic moats’ (meaning competitors can’t easily steal market share)
- Have good track records when it comes to growth and investor returns
- Have attractive future growth prospects
- Are very profitable
- Generate a lot of cash
- Have strong balance sheets (low debt)
- Are not too cyclical (meaning profits aren’t going to tank in the next economic downturn)
A great example of a high-quality company is software company Microsoft (which is one of my largest holdings right now). It meets all that criteria. And look how it has performed over the last decade. Since I bought it in 2019, it has risen from $150 to $400.
Strong long-term returns
Now, as I mentioned earlier, quality investing has shown to deliver tremendous results over the long run. For example, since its inception in 1994, the MSCI World Quality index has returned 11.9% a year versus 8.3% for the regular MSCI World index.
Meanwhile, Terry Smith, who employs a strict quality approach in his Fundsmith Equity fund, has delivered returns of about 15.4% a year since his fund’s launch in 2010.
Then, there’s Warren Buffett, who’s another major proponent of the quality investing style. Since 1965, he’s generated returns of around 20% a year.
I will point out that this style doesn’t work all the time. There will be periods when it underperforms. (eg when cyclical stocks like miners are ripping higher). Overall though, it’s shown to be a very effective approach.
A high-quality UK company
The good news, for UK investors like myself, is that there are plenty of high-quality companies on the London Stock Exchange.
One example is property website Rightmove (LSE: RMV).
It has a wide economic moat due to its well-known brand, and a great track record when it comes to growth.
It’s also extremely profitable. Over the last five years, for example, return on capital employed (ROCE) has averaged a stunning 285%, making the company one of the most profitable businesses in the FTSE 100.
Meanwhile, it tends to be insulated from the ups and downs of the UK property market due to its business model.
Of course, there’s no guarantee that the stock will deliver attractive returns from here. There’s always the chance that new technology or new competitors could disrupt the growth story.
Overall however, I see it as a great stock for the long term. So I’ve built up a decent position in it.
At today’s valuation (the P/E ratio is about 20), I think it has the potential to deliver attractive long-term returns.
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Edward Sheldon has positions in London Stock Exchange Group Plc, Microsoft, Rightmove Plc, and Fundsmith Equity. The Motley Fool UK has recommended Microsoft and Rightmove Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.