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The joy of investing in quality companies is not only that they tend to outperform, but also that they do so so well thanks to their habit of holding up well during bear markets.

This week, Citywire Elite Companies is looking for quality stocks among the companies favored by the world’s best money managers. This is a new screen in our regular list of data dives.

For readers who want to skip the whys and wherefores of all this and jump straight to the stocks, scroll to the end of this article, where there is a list of the 22 highest-rated elite companies.

Read our recent profiles of two of the world’s best investors

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Elite + quality

Citywire’s groundbreaking reviews of elite companies are something of a quality screen in their own right.

For companies to achieve a high rating, they typically need high-conviction support from several of the world’s best portfolio managers. This means their tires should have taken a thorough kick.

Meet your new equity research team: the world’s 277 best portfolio managers!

However, the managers tracked by Elite Companies – about 3% of the top 10,000 global equity managers – employ a variety of investment strategies, ranging from value to momentum and many others in between. We are therefore introducing screens resolutely focused on quality.

A key attribute of quality businesses is consistency. This means that screens intended to identify quality should return many of the same names each time they are run.

With this in mind, Elite Companies is putting together several screens of varying quality, each of which will be featured approximately once every six months as part of our regular lineup of weekly data dives.

Data Dives on Elite Companies

Each week, we conduct one of six (previously five) simple but powerful analyzes of Citywire Elite’s top-rated stocks to unearth investment ideas for readers. We go through a different screen of the six screens each week. They are:

Recipe for the composition

Two ingredients determine the ability of high-quality companies to create shareholder value – or “compound”.

• The first is a company’s ability to generate high returns from investments made in its business. For high-quality companies, these returns should be significantly better than what shareholders would expect in the market if the company had returned cash rather than reinvesting it.
• The second factor determining a quality company’s ability to create value is its ability to reinvest money – its growth potential.

Criteria

This week’s screen focuses primarily on the first of the two compound ingredients: ROI.

The return metric our screen uses is return on invested capital (ROIC). This ratio attempts to show how effective a company is at generating profits at the operational level, before financing choices (e.g. use of debt) come into play.

The screen also focuses on company margins, based on earnings before interest and tax (Ebit) as a percentage of sales.

Ebit margin is a great indicator of quality because when it is high it often means that a company has a product or service that its customers are willing to pay for because they consider it special and unique.

High Ebit margins also suggest that a company’s competitive advantage has not been overwhelmed by high operating costs, as may be the case for young, emerging growth companies, for example. The screen also looks for improvements in these quality measures over the past few years.

Other tests used by the screen look for decent profit-to-cash conversion, limited financing costs, and forecast earnings growth.

The mecanic :

We start by selecting the top 20% of large and small cap companies (market value less than $2.3 billion) along with the elite investors we follow. All companies must be rated at least AA.

We then select those who check the following boxes:

• ROIC is in the top third of all selected companies in each of the last three years and is higher at the end of the period than at the beginning.
• Ebit margin in the top third of all companies examined in each of the last three years and higher at the end of the period than at the start.
• Forecast earnings per share (EPS) growth for each of the next two 12-month periods and EPS improvement over the past three months.
• Interest coverage (Ebit/financing charges) more than five times.
• Cash conversion of over 80% based on either free cash flow to profit after tax or operating cash flow to earnings before interest, taxes, depreciation and amortization (Ebitda).

The results

Some of the companies highlighted on the screen reek of quality more than others. For example, rated AAA Nvidia (US:NVDA) looks like a quality builder on steroids, although questions arise about how long the current AI spending spree fueling staggering growth will last.

Compare that with the AAA rating Plute Group (US:PHM), which has clearly fallen on hard times (see chart below).

It’s not surprising that Plute has made losses at times in its history given that it is a housebuilder and housebuilding is a very cyclical industry. However, this is a quality company within this industry.

In the words of one of its 13 Elite backers, Jay Kaplan, manager of the Royce Small Cap Value fund: “It is a leading company in its sector, with a management team that has an excellent track record of efficient capital allocation that focuses on shareholders. Back.’

We’ll take a closer look at some of the companies highlighted by this quality review over the coming weeks. For now, here are the results, ranked by popularity among the top investors whose holdings Citywire Elite Companies tracks.

Source: FactSet. EPS = earnings per share. PEG = price growth relative to earnings. Forecast based on the next 12 months.