In times of market tumult, when the daily headlines scream fear and the broader public scurries for the exits, the seasoned investor remains calm. For those of us with a long-term horizon and a preference for businesses of enduring substance, such periods offer something truly rare: the opportunity to acquire quality at a discount. In today’s article, I shall explore the characteristics of the companies I have sought to add to the portfolio during recent market volatility.
Simplicity and Durability
What exactly is “quality”? It is a word oft thrown about yet seldom defined with the care it deserves. To my mind, a high-quality company is one that can consistently deliver a return on capital employed (ROCE) of more than 10% – not in a single fortunate year, but as an enduring average over a decade. A business that earns strong returns on its invested capital year after year demonstrates a durable competitive advantage and sound stewardship; qualities which tend to outlast any particular market cycle.
Equally important to quality is the condition of the balance sheet. Quality companies do not hide behind excessive leverage. They grow by reinvesting retained earnings, not by borrowing heavily in the good times and pleading for mercy in the bad. Of course, debt has its place, but if it becomes the engine of growth, you will always fear the day that the fuel supply runs dry.
Earnings per share (EPS) is another cornerstone of quality which I seek. In a world where share prices reflect EPS, the best companies grow theirs each and every year – steadily, unspectacularly, but unfailingly. This kind of consistency is a mark of operational excellence and discipline. It shows that the business can weather storms, manage costs, and continue to generate real, compounding value for shareholders.
Quality Checklist:
- Average ROCE > 10% over 10 years
- Annual EPS growth every year for 10 years
- Low or conservative debt levels
- Dividend cover ≥ 2x (historical and forecast)
- Consistent free cash flow
Yield: A Reward, Not a Trap
Dividend income remains a cherished element of my own portfolio strategy, but I learned long ago not be seduced by high yields alone. Too often, an outsized yield is a sign not of generosity, but of distress. Instead of chasing headline figures, the wise investor looks to the safety of the dividend. Over the past decade, the dividend should have been covered at least twice by earnings each year. Looking forward, forecast cover should also be comfortably over two times. This prudent margin helps protect against the all-too-common dividend cut, which can strike suddenly and without ceremony.
Just as important is the source of that dividend. A company should generate ample free cash flow, as after all; dividends are paid in cash, not accounting entries. If dividends are funded through borrowing or asset sales, the yield is an illusion.
“Yield is no substitute for quality. One is tempted to treat it as a gift; too often, it is a warning.”
Where to Look for Durability
While quality can be found across multiple sectors, certain industries are more naturally endowed with resilience. Consumer staples, healthcare, and infrastructure-oriented businesses often exhibit the characteristics we seek; necessity, repeat custom, and pricing power. They tend to trade at a premium in calmer markets -but may become temporarily overlooked when panic sets in.
One need only recall how shares in certain stalwarts such as Unilever, Diageo, or RELX were cast aside during previous storms, only to recover and reward the patient investor handsomely. Quality is often temporarily discounted but seldom permanently impaired.
Beyond the numbers, pay attention to subtle signals of confidence from those closest to the business. Insider buying, particularly during market weakness, can be a quiet but powerful vote of confidence. Similarly, the presence of long-term institutional holders, especially those known for rigorous selection criteria, can offer reassurance that one is not alone in one’s judgement.
Timing the Entry: Let the Market Come to You
While I have never been an advocate of day trading or short-term speculation, there is merit in observing certain technical indicators that may offer clues to market sentiment.
- 200-day moving average: If a stock trades well below this long-term trend line, yet the fundamentals remain intact, it may be a sign of temporary mispricing.
- RSI (Relative Strength Index): A recovery from oversold levels can suggest that the worst of the selling pressure has passed.
These are not guarantees, but they can offer a helpful nudge when used in conjunction with sound fundamental analysis. Think of them as the valet checking the weather before you depart; not definitive, but worth consulting.
In Closing: Discernment Over Drama
The finest businesses do not lose their quality simply because their share prices fall. On the contrary, a downturn often returns their valuations to a level that offers a more generous margin of safety. When others are selling indiscriminately, the long-term investor should be sharpening his tools and readying his ledger.
Discipline, patience, and a firm commitment to quality are the virtues that separate the transient trader from the enduring investor. As Sir John Templeton so wisely observed, “The time of maximum pessimism is the best time to buy.”
So the next time the market shudders, do not be drawn into the frenzy. Wait, watch, and prepare.