TOL - 11th Dec, 2024
5 ways to identify high-quality ASX companies (and 14 stock examples)
Using MarketMeter's research, we put three stock pickers to the test and asked them to highlight the highest-quality stocks on the ASX.
Whenever I ask different fund managers what quality means to them and where quality manifests in the Australian stock market, I get a different response. Yes, there are classic names like CSL and Macquarie Group, but just because a company is large does not make it a high-quality company. Nor is it the case that all small and micro-cap companies are exclusively low-quality... far from it.
So, in this wire, I'm testing the concept of "quality" and the different qualitative measures that make up a quality stock with the help of Elise Kennedy from Schroders, Andy Forster from Argo Investments, and Kerry Series from NorthStar Impact. Together, they'll each name one stock from each of the following five categories:
- Effectiveness of CEO
- Execution of strategy
- Credibility
- Earnings quality
- Sustainable competitive advantage
These five categories were ranked the 'Most Important' in MarketMeter's institutional investor sentiment research. The company asks around 150 domestic and offshore institutions to score publicly listed companies from one to 10 across 27 corporate performance categories.
So, without further ado, let's go through 14 stocks in (approximately) 15 minutes.
Effective CEOs
Kerry: Scidev (ASX: SDV) - The company provides services and products for water intensive industries. But where it gets really exciting, according to Series, is not just the fact that the CEO is the founder but that the company is creating cleanup solutions for PFAs. PFAs are sometimes referred to as the "forever chemicals" due to their lasting impact on humans and the environment.
"What's great about Sean is he was the founder of the PFAs business that went into SciDev, which he started in 2016. He was ahead of his time."
"It's now a massive opportunity. In their latest deck they talked to a US$250 billion opportunity in America alone," Series noted.
Andy: Treasury Wine Estates (ASX: TWE) - TWE's struggles in expanding its premium wine customer base outside of China have been well-telegraphed. But under CEO Tim Ford, that appears to have changed.
"We think Tim did a really good job of being able to pivot that business to grow into alternative markets outside of China while still maintaining a footprint," Forster said.
"He's moved [the company] into the premium end of the market away from things like bulk and commercial wine. He's really premiumised that portfolio so it's less cyclical in terms of being impacted by what's happening in the agricultural space, he added.
Elise: Xero (ASX: XRO) - In February 2023, Sukhinder Singh Cassidy stepped into the top job at Xero, succeeding her predecessor, who had been in the top job for five years prior. Kennedy nominates this company for its rare status as a tech company with meaningful free cash flow.
"Why I choose this company is the meaningful free cashflow and the delivery around the OPEX, which is a unique thing for a tech company ... it's clear as we start to see it move from a position of no cashflow to about $200 million in free cashflow in the last half, that's becoming a more meaningful metric."
Companies with great strategies and great execution
Elise: REA Group (ASX: REA) - This pick should not surprise quality-hunting investors. It's often earmarked by quality stock pickers as a favourite on the ASX and TMS Capital's Ben Clark once described it as a better real estate investment than a Sydney home - which is quite the compliment! But how does it keep its moniker as a high-quality company? By reinventing itself.
"The one that I keep on being surprised by is how REA reinvents itself, as well as its ability to keep on getting more out of that market," Kennedy noted.
"If you go back to 2012, when it was the subscriber-based market and that was the market that they had. Then, moving towards a vendor-paid market which is leveraged more towards the housing market. They have just been able to continually execute, change their strategy, and keep on growing."
Kerry: AI Media (ASX: AIM)—This Aussie success story was founded as a software company more than 20 years ago. But its real defining moment may have been when it acquired a competitor with the hardware to take it to the next level. Today, it's staring down the barrel of a near-$2 billion opportunity set.
"In 2021, they made an extremely important strategic acquisition of a company called EEG, which essentially owns the hardware that's used in all the media companies. Then, that hardware provides open access to any company with a transcription or captioning service. AI Media have subsequently evolved their product."
"It is now, in their opinion, market-leading. It has the highest accuracy of non-human and they actually think it's now exceeding human captioning as well," Series said.
Andy: Reece (ASX: REH) - Not every company can boast of being the destination for an entire industry, but Reece can. As Forster put it, "If you ask any plumber, it's the go-to place where they go to get all their plumbing gear." But that's not the only thing that impresses Forster.
"They've got a thing called the Reece Way. There are 10 principles and one of their principles is to create customers for life. This business is very customer centric. They've moved into the US after spending a decade looking at that market. They've been very measured going into that market and their execution to date has been outstanding."
"They're not relying on an investment bank to bring them a deal and tell them how to get into a market. They're growing it themselves, in a very measured way, and they're thinking multi-generationally about how this business is going to be positioned in the future," Forster said.
Companies that are viewed as credible
Andy: Wesfarmers (ASX: WES) - Forster may view the big box conglomerate from Western Australia as "big" and "boring" but it's hard to go past its outstanding operations.
"They really are an outstanding retailer in how they operate in their space. I think they are very good allocators of capital in their business. They have a strong history of earnings growth, are a consistent dividend payer, have a good balance sheet and, as I said on the credibility side, I think Rob does a great job communicating that to the market," he said.
Elise: Car Group (ASX: CAR) - As Kennedy puts it, "their execution strategy when it comes to offshore is unique versus some of its peers in the online media space."
"And sure, they may have said that they're paid a higher multiple for the Trader Interactive acquisition, but what has to come through is a replication of their strategy that they've duplicated that into the US even though the market is struggling. For me, that is something where the credibility of the management comes through. They say what they're going to do and execute it. That, to me, is a unique capability there," she added.
Kerry: Aspen Group (ASX: APZ) - This affordable housing provider is working in a much-needed area of the market and, as Series highlights, is led by two managers who consistently impress the market.
"They've built an amazing business and in such a much-needed part of the market, consistently met guidance and typically upgrade one to two times through the year," Series said.
Companies with high-quality earnings
Kerry: SDI Group (ASX: SDI) - A family-founded and run business, SDI is a dental products manufacturer who seem to have, at least in Series' view, no cavities in their balance sheet.
"It's an unknown, amazing Aussie success story. It's a global company with market leading dental products. They're very good at guiding market to where the earnings are going to be and very good correlation between operational cashflow and reported earnings," Series praised.
Andy: Commonwealth Bank (ASX: CBA) - It may be the world's most expensive bank and a screaming sell for most of the sell-side but its earnings quality and leadership in retail banking, at least in Forster's view, cannot be denied.
"It is hard to go past the earnings quality of Commonwealth Bank. The company clearly dominates the retail banking space, is very strong in mortgages, and absolutely dominates the deposit space which gives it a funding advantage. It's the dominant primary financial institution for people in the country."
"It's clearly had a phenomenal run but I think that really reflects that it really is a high-quality company within the Australian market," he said.
Sustainable competitive advantage
Andy: TechnologyOne (ASX: TNE) - If you've heard of this business, chances are it's because FNArena's Rudi Filapek-Vandyck loves talking about it. But, as he noted in his recent wire, it's a quality company for a reason and its growth has been nothing short of stunning. And it appears Forster would at least partially agree with this sentiment.
"It absolutely dominates in the [SaaS] space and it's incredibly entrenched. These guys have got amazing technology. They are very innovative and they're providing a lot of efficiencies for councils. They also do it to universities as well and provide cost savings. But for us, that's a business that really has got a sustainable competitive advantage," he said.
Elise: Telstra (ASX: TLS) - Although not often considered a growth play, Kennedy considers Telstra's push into 5G a symbol of how it's tried to gain an extra edge over the competition in recent years.
"Having watched them early in the investment of that 5G phase, it's really given them that headroom and ability to just keep on gaining an extra edge over some of their competitors that were more focused towards the industry's consolidation ... I do think it makes it a really hard point for others to come through and therefore it has created that economic moat that we look for in a lot of our stocks," Kennedy said.
Kerry: Botanix (ASX: BOT) - The Aussie small-cap biotechnology company has been working for years on a treatment to deal with hyperhydrosis (excessive underarm sweating.) The drug has now received regulatory approval, providing those afflicted with this particular ailment to purchase this option instead of botox or very strong deodorants.
"The process of clinical trials and getting through the FDA is obviously a very long, extensive, expensive process. But once you've got it, you have a sustainable competitive advantage for a long time," Series noted.
But wait, that's not all!
In the rest of this session, we also discuss how fund managers deal with a range of scenarios - like how long should you stick with an underperforming company or when management's strategy conflicts with your views on where the company should go from here. This panel really is a case of "come for the stock picks, stay for the unbeatable insights" - and I think you'll get a lot of value from watching the entire session.
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Hans is one of Livewire's senior editors. He is the creator and moderator of Livewire's economics series "Signal or Noise". Since joining Livewire in April 2022, his interview record includes such names as Fidelity International Global CIO Andrew McCaffery, JPMorgan Asset Management Global CEO George Gatch, and Lazard Chief Market Strategist Ron Temple just to name a few. He has a double degree in economics and journalism.
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14 stocks mentioned
Hans is one of Livewire's senior editors. He is the creator and moderator of Livewire's economics series "Signal or Noise". Since joining Livewire in April 2022, his interview record includes such names as Fidelity International Global CIO Andrew...
Expertise
Hans is one of Livewire's senior editors. He is the creator and moderator of Livewire's economics series "Signal or Noise". Since joining Livewire in April 2022, his interview record includes such names as Fidelity International Global CIO Andrew...
Expertise
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