Among the various investment factors, quality has all-weather properties, indicating it is a relevant consideration for today’s frantic market setting.
While there’s fluidity in defining quality and various exchange traded funds with exposure to the factor reflect as much, companies with the wide moat designation often display quality characteristics. That’s a sign that the VanEck Vectors Morningstar Wide Moat ETF (MOAT) could be a credible destination for quality-minded investors.
“While headline inflation continues to grind higher, hitting new multi-decade highs, investors are increasingly more worried about a potential recession. Buying quality is a typical reaction to an economic downturn. As investors become more cautious, they rotate towards companies best positioned to withstand a slowdown,” according to BlackRock research.
The $6.9 billion MOAT follows the Morningstar Wide Moat Focus Index and is home to 50 stocks. Owing to stringent index inclusion criteria, MOAT’s components obviously check the wide moat box, but many can also credibly be deemed quality ideas.
“This leaves the question of what constitutes a ‘quality’ company? When describing quality, one of the more ambiguous investment styles, investors typically emphasize characteristics such as earnings consistency, profitability and manageable leverage,” added BlackRock.
Plenty of MOAT holdings have steady earnings, impressive margins, and tolerable levels of debt or outright pristine balance sheets. Some MOAT member firms offer another trait investors should consider, particularly with inflation remaining high: Pricing power.
“While these characteristics are likely to be valued during the current downturn, today’s circumstances are unique. Despite a cooling economy inflation remains at a 40-year high. Stubbornly high inflation is both a drag on consumer spending and source of rising input costs,” noted BlackRock. “As a result, investors need to worry about both lower top-line growth and collapsing margins. Given these unique circumstances, investors should adjust their definition of quality to include another characteristic: pricing power.”
Sectors with favorable pricing power capabilities include healthcare and consumer staples. Those two groups combine for almost 19% of MOAT’s portfolio, according to issuer data.
The pricing power possessed by some MOAT holdings is relevant over the near term and the long term because the reality is that forecasting when inflation will decline in material fashion is a fool’s errand.
“Going forward investors will have to have to contend with sticky inflation, a slowing economy and a less ebullient consumer. As is typical in slowdowns, consistent earnings will take on a newfound importance. Companies most likely to maintain earnings with be those most likely to hold the line on prices and maintain their margins,” concluded BlackRock.
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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.
