3 themes that highlight future quality

A lot of time and effort is being expended by investors attempting to guess the future path of monetary policy in the US and elsewhere. Irrespective of the economic backdrop, we are focused on picking a selection of companies that meet our Future Quality criteria. We spend significant time assessing the quality of management teams, the strength of the franchises that they manage and the strategic flexibility afforded to them by their balance sheets. Once we have concluded on these aspects, the final discipline is a careful appraisal of the stock’s valuation. There are plenty of quality businesses that are fairly or even over-valued. There are many more that fall foul of our other requirements.

Our valuation discipline is anchored around metrics prioritising cash flow generation and growth. At times like these, when central banks are keen to withdraw liquidity and restore their monetary firepower for future crises, this is a valuable exercise.

With cheap financing abundant over the last few years, there is an above average number of plausible sounding new technologies available to investors at present. Even if we can see the potential in some of these, we won’t invest in them if there is no realistic path to cash returns over our forecast period. History suggests that the ultimate beneficiaries of these technologies will often look very different to today’s view and many will likely fail to deliver commercial success.

In 2019 we’re seeing a number of themes that are providing good Future Quality stocks for the portfolio. These include:

Value-based healthcare in the US

Demographics fuel growth in demand for healthcare services. They are also part of the problem, as increasing numbers of people live for longer, with more chronic illnesses. The need for public providers to deliver care for these conditions as efficiently as possible will only become more pressing. The US is increasingly matching payment to demonstrable patient benefit as a result. We have several stocks in the portfolio that are positioned for this growth, including LHC Group, Anthem, and Resmed.

China

Whilst rising trade tensions, tighter bank lending and shifting Chinese economic imperatives continue to weigh on some economic sectors, others remain better placed. We still believe that businesses that offer the building blocks for the long-term economic development of China offer attractive growth. For example, low insurance penetration and limited social welfare provision, together with a growing need for retirement savings should underpin growth for businesses like AIA and Prudential. The ongoing modernisation of China’s healthcare infrastructure also holds opportunities for Sinopharm and Philips. 

Cloud computing and the Industrial Internet of Thing

In recognition of stretched valuations and the blurring of cyclical / structural growth that these valuations often reflect, we remain very selective when investing in the technology sector. We are still willing to invest in areas where we can see a genuine path to long-term growth, allied with strong current cash flow generation. Cloud computing and some of the capabilities that this supports (such as machine learning) possess these attributes. Microsoft, Red Hat, and Keyence are key holdings in this area.  

It is a well-known joke that stock markets have predicted nine of the last five recessions. Whilst the market weakness that we saw in Q4 2018 was no joke and some of the concerns are very real, there are still reasons to be optimistic for parts of the economy. The excesses that heralded the last serious slowdowns are generally absent and consumers are generally in reasonable shape. We do, however, believe that the economic tide is less likely to lift all boats from here. Instead, those with the most astute captains and the most flexibility are likely to better navigate more choppy waters. This should play well for the pillars that underpin Future Quality investing.

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