The top 10 ASX 100 companies in terms of earnings quality, according to MarketMeter

It’s not about the money they say… except that investing *really* is about the money. Investing is not just a fluffy feel-good venture. We invest to build our wealth, earn returns, support our lifestyles. The ability of the companies we invest in to generate solid and consistent earnings is therefore an essential, not a side bonus.

Seeking out these valuable companies can be fraught.

While investors may gravitate towards those companies simply paying the highest earnings per share, they need to be mindful of risks like company distress. That is, are such companies paying out more than they can really afford to? Can such companies continue to pay out in coming years at the same levels?

Earnings quality is critical. Where should an investor start?

MarketMeter has shared its research on the top ranked ASX-listed companies by institutional investors. There are some names you might expect, and others you won’t.

I also spoke to Michael Wayne, managing director for Medallion Financial Group on his views on earnings quality. While he agrees with some of the inclusions, he believes there is a sector gap in the top 10. 

What is MarketMeter?

MarketMeter is an interactive market insights platform that measures and benchmarks institutional investor perceptions of Australian listed companies, who find it a reliable risk management tool to understand their performance in the eyes of institutional investors.

“With the benefit of super fund data partnerships, MarketMeter has a deep, high-quality data pool which can help fund managers understand how their stock perceptions differ from their peers, category by category, and by how much,” says Nicholas Coles, Managing Director and co-founder at MarketMeter.

The platform enables institutions to score companies from 1-10 on a range of factors. Participants are then able to see how their views compare to those of other professional investors. Companies are evaluated across 27 factors grouped in categories of financials, ESG, management, strategy and engagement.

Note: This piece is the fourth in our six-part series looking at and evaluating MarketMeter’s exclusive data. You can view the previous pieces below:

Investment Theme

The top 10 companies for Investment Desirability, according to MarketMeter

View

Investment Theme

The top 10 companies for Sustainability Reporting, according to MarketMeter

View

Equities

The top 10 ASX 100 companies in terms of Growth Prospects, according to MarketMeter

View

Looking for earnings quality

Earnings falls under the financials categories. Earnings quality means different things to different people – some focus on dividend size, while others might look at future cashflow. MarketMeter defines it as follows:

“Earnings per share measured primarily against other ASX Top 100 companies, the market in general, but also against the company in question’s own earnings’ history. This includes consideration of revenue diversification streams, ability to withstand external shocks, as well as consistency in reporting”

Top 10 ASX 100 companies in terms of earnings quality

These are the ASX 100 companies that fund managers scored highest with regard to Earnings Quality. The list appears in order based on the results of the most recent MarketMeter research.

1. REA Group (ASX: REA) 
2. Xero Ltd (ASX: XRO)
3. BHP Ltd (ASX: BHP)
4. Ansell Ltd (ASX: ANN)
5. Transurban Group (ASX: TCL)
6. Aristocrat Leisure Ltd (ASX: ALL)
7. Carsales.com Ltd (ASX: CAR)
8. JB Hi-Fi Ltd (ASX: JBH)
9. Macquarie Group (ASX: MQG)
10. AMCOR PLC (ASX: AMC)

Top 10 ASX 101-200 companies in terms of earnings quality

These are the ASX 101-200 companies that fund managers scored highest with regard to Sustainability Reporting. The list appears in order based on the results of the most recent MarketMeter research.

1. Domain Holdings (ASX: DHG)
2. Boral Ltd (ASX: BLD)
3. BWP Trust (ASX: BWP)
4. Deterra Royalties Ltd (ASX: DRR)
5. West African Resources Ltd (ASX: WAF)
6. Lovisa Holdings Ltd (ASX: LOV)
7. Brainchip Holdings Ltd (ASX: BRN)
8. Telix Pharmaceuticals (ASX: TLX)
9. Capricorn Metals (ASX: CMM)
10. Breville Group (ASX: BRG)

The Medallion Financial perspective with managing director, Michael Wayne, 

What are your thoughts on the lists?

There is some overlap between our own views and these lists.

Of the ASX100 list, we hold five companies for clients. There was less overlap in the 101-200 list. That list included more miners. We struggle to see how the cyclical nature of the mining industry can allow many miners to be a part of earnings qualities lists. When we look at earnings quality, we like predictability and the ability consistently compound earnings which is more difficult to ensure in cyclical industries like mining.

Do any of the companies in the list raise concerns for you in terms of outlook?

Domain is one we would be cautious on. It's no secret that property is under pressure in the current environment. The number of listings, sales and rentals, has been under short-term pressure. Less listings can make it more difficult for Domain to do well. It becomes less likely that vendors are willing to pay for premium advertising in this sort of environment. We prefer REA Group over Domain because REA Group has a stronger business and is more entrenched in the industry despite facing similar pressures.

Another one is JB Hi-Fi. Everyone is familiar with the inflation story and rising interest rate environment. So far Australians haven't cut back on discretionary spending. JB Hi-Fi has been able to increase the pricing on a lot of its electronics and household products which has been able to incubate them a bit. There's only so far consumers can take when it comes to price rises amid inflation and rising interest rates.

The third one is Boral. Management has indicated that due to price rises and operational leverage, they may not be able to deliver on margin expansion they'd expected due to inflationary pressures. Extreme rain and flood events, higher energy prices could also confront Boral.

Finally, Brainchip is a bit of a favourite small-growth business however it's very expensive. It trades on 24x book value, 133x sales. It's never generated a net profit so I can't see earnings certainty. It wouldn't meet our criteria for earnings quality.

What companies do you think are missing from the list?

One area we noticed was omitted was the healthcare sector. 

Many of the ASX listed healthcare companies have a long history of consistent earnings growth and good balance sheet numbers. Often healthcare businesses have a reliable customer base, very forecastable earnings and a competitive advantage to enshrine earnings growth. 

What would be your top picks for earnings quality?

The first three are in the healthcare space.

A company such as CSL Ltd (ASX: CSL), the largest healthcare company on the ASX, has many decades of consistent double-digit earnings growth, a strong competitive advantage in blood plasma which helps enshrine its consistent earnings growth. Or Resmed (ASX: RMD) which is involved in the sleep apnoea space. Fisher & Paykel (ASX: FPH) ticked the boxes for earnings quality in the lead-up to covid. It's going through a period of challenge to return to a normalised environment but is likely to get there again.

Some tech businesses like Altium (ASX: ALU) reach our criteria. IDP Education (ASX: IEL) is another one. Finally, Pro Medicus (ASX: PME) which is a healthcare/tech hybrid. It has demonstrated steady growth in revenues, earnings, margins, ROE and dividends each year for the last 10 years

How important is an assessment of earnings quality in your own process?

Earnings quality is high on the list. We believe if a company's earnings remain at high quality and continue to grow, despite cycles and short term noise, the price should follow that earnings trajectory. 

Valuation is also very important. The idea to purchase attractive earnings quality at a good price. We're not deep-value though, we're happy to pay high multiples if the earnings quality justifies it.

Competitive advantage and MOAT are key.

We like companies that are capital-light. That means they don't have a lot of tangible assets that need a lot of maintenance. Businesses that are capital-light tend to have high and sustainable margins.

We also like companies that are investing now for future growth. This can have the effect of depressing earnings now for future growth as they are sacrificing to invest into the future.

Another characteristics we look for is free cashflow which allows companies to invest in growth without going back to the market.

It's important to also pay attention to the macro environment. We look for certain sectors where there are natural tailwinds like aging populations or emerging middle classes. These are long term thematics that can point you in the direction in terms of sector selection. Once you've identified where there is a lot of momentum in the economy, you can do the bottom-up analysis of company balance sheets and earnings quality.

Never miss an insight

If you're not an existing Livewire subscriber you can sign up to get free access to investment ideas and strategies from Australia's leading investors.

I'll be in charge of asking the questions to Australia's best strategists, economists, and fixed-income fund managers. If you have questions of your own, flick us an email: content@livewiremarkets.com