Quality and Fundamentals (Part 5)

I continue today with my mini-series on the difference between high-quality stocks and solid fundamentals and what is necessary for the SSG methodology.

The second half of Part 4’s penultimate paragraph goes too far to imply that a history of consistent earnings [and/or sales since both ultimately go together] may actually be dangerous for picking good stocks. The bar chart suggests most companies have their day of reckoning but let’s remember the difference between concrete definition for Google AI and natural subjectivity inherent in the visual inspection. The first paragraph of my rebuttal mentions some stocks have data excluded to pass visual inspection [with many others being so inconsistent that even select omissions cannot save them]. Data exclusion is often due to nonrecurring items and makes good sense. Perhaps more importantly, over the course of 10 years many companies will have a slight YOY earnings dip(s) or more severe declines while still being “up, straight, and parallel” overall. The bar chart allows for none of this accomodation.

I also do believe some CEOs and management executives have the secret sauce when it comes to operating a company with consistent growth. Such laudable past performance likely continues into the future and a reckoning doesn’t mean an abrupt end to positive and consistently increasing numbers. The greatest stock market winners continue their runs for many years.

I think all of this is to say what matters most for the SSG methodology is historical consistency and the ability to pass visual inspection. We base studies on long-term growth estimates but for companies with low earnings predictability, the only confidence regarding said estimates is in their likelihood to be wrong and/or to fluctuate wildly over time.

To some degree, the SSG needs Quality [of which earnings predictability is a component] stocks but let’s realize magnitude is not part of the Part 3 discussion about consistently growing earnings. The door therefore remains open to value [low P/E] stocks as well as high-quality growth stocks [more likely to be high fliers].

And yes, companies can have good track records of growth and still be value stocks. They may be in mature or “unsexy” industries (e.g. utilities or consumer staples) that get overlooked. Given a long history of consistent [high] growth (earnings and dividends), they are [high-] quality value stocks due to a low P/E or P/B (book) relative to peers or the broader market. When a high-quality growth company has a temporary setback (e.g. bad earnings report, management change, out-of-favor industry) and suffers a stock correction, it may become a promising value play if the long-term growth story remains intact.

I will continue next time.

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