You may be worried - with the FTSE 100 having rallied over 50 per cent off its March lows at the time of writing - that you've missed the boat with equities. After all, who would pile into shares, even in big companies, that have already doubled, tripled, quadrupled or more? Fear not. While cyclical shares in particular have rallied in spectacular fashion, there are still many high-quality companies that the market has simply left behind. It's not too late to buy them. But first you have to find them.
What do we mean when we talk about 'quality' companies? The word means different things to different investors. For some, it's consistent earnings momentum. For others, it's balance sheet strength and cash flow. And others look at more subjective criteria, such as management strength or competitive position.
So 'quality' shares can be anything from fantastic fast-growing small caps to definitively boring, worthy large stocks with quality balance sheets. In this feature, though, I'm going to focus on a fairly narrow set of parameters to find the companies that I think will represent great investments over what could well be a turbulent few years. I'm going to draw on the research of two City analysts I particularly admire. But first let me explain why I think that seeking out quality is the way forward.
Dogs on acid
In the 204 trading days between 19 May 2008 and 3 February 2009, the FTSE 100 fell by more than 34 per cent. But a total of 1,400 shares quoted in London fell by more than 75 per cent. They were largely cyclical stocks such as miners, housebuilders and retailers. Banks ran into a spot of bother, too, of course.
Fast forward to the period between 4 February and 16 October, and the FTSE 100 has increased by 22 per cent. Yet the companies that fell so hard rose on average by 180 per cent. That doesn't mean they recouped all their losses – something that's fallen by 75 per cent needs to rise by 300 per cent to get back to the same level – but it's still an almighty rebound. And like the slump that preceded it, it's been concentrated in those sectors that are perceived to benefit from a sudden uptick in global demand: miners, industrial metals, plus sector-specific factors such as car-scrappage schemes and bank rescue packages. For example, miners Vedanta and Kazakhmys were down over 79 per cent in the downturn but both have risen hugely in the upturn (by 279 per cent and 348 per cent respectively).
This begs two questions. Can the rebound go on? And where does this so-called 'dash to trash' leave those shares that have missed out?
Andrew Lapthorne, an analyst at Société Générale (SocGen), thinks that institutional investors will soon realise they are paying very high prices for future earnings growth at many of these companies. The two miners highlighted above are trading at around 29 times forecast earnings, for instance.
And Graham Secker at Morgan Stanley points out that those companies eating the dust of the cyclical rally are trading on record low valuations. A gaggle of reliable growth stocks he identified in a September research report have "underperformed the market by 12 per cent since March" and are trading at a dividend yield higher than the 10-year gilt rate.
