13 high quality growth companies primed to outperform

Due to heightened inflationary fears and interest rate hikes, it’s been a difficult few months for quality and growth-orientated investors that have endured the market performance equivalent of the Texas two-step: Up and back, swing to the left, and now back to where we started, and here we go again, woohoo - grab your partner.

In light of heightened volatility and the susceptibility of growth and quality stocks to interest rate movements - due to the longer duration of their cashflows – Market Index asked the analysts at Stock Doctor to run their ruler over ‘best and fairest’ stocks in the land.

While uncertainty can never be eliminated from the investment process, Stock Doctor’s analysts aim to minimise misjudgement by applying a qualitative overlay to their stock selection.

What the analysts' research has convincingly concluded is that while markets go through cycles, history suggests quality companies are more likely to outperform over the long term.

At the recent Berkshire Hathaway Annual Conference, Warren Buffet reminded investors that quality companies will not only be able to raise prices to maintain inflation adjusted profits but also withstand the capital erosion from inflation.

In the chart below you can compare the performance of various styles of investing over the last five years.

Qualitative overlay

We asked Stock Doctor to filter out stocks listed on the ASX based on key criteria - management performance, operational risks, forecast earnings revisions and short interest - which everything being equal, would help them achieve higher risk premiums over the long run.

Without drilling into the minutiae of detail, key criteria Stock Doctor filtered on to find high-quality growth companies included:

• Strong financial health, including cashflow and profits, with manageable amounts of debt and liabilities.

• High return on equity (ROE) or return on invested capital (ROIC) – to compensate investors

• Ample net profit margins: Companies with a strong market position (i.e. economic moat) tend to exhibit outsized net profit margins

• Robust earnings quality: Stocks exhibiting high cash conversion, and free cashflows consistent with reported profits

• Positive outlook: Companies that can demonstrate a trend of consistent and sustainable earnings over the long term

High quality 'star stocks" highly oversold

At face value, recent market volatility may present rare opportunities for investors looking to buy oversold quality exposures.

As a result, we asked Stock Doctor to go in search of high-quality 'Star Stocks' that have fallen significantly over the last 6 months, yet are still anticipated to report robust earnings growth over the next 12 months.

In other words, the recent market sell down has little to do with company specifics and strong structural growth embedded within these quality stocks.

While banks and resource stocks are surprisingly absent from the Stock Doctor’s 'baker’s dozen' of favoured stocks, the predominance of health care, software and retail stocks points strongly to the long tail within Australia's post-covid recovery story.

Having been sold down -40.4%, -33.9% and -32.9% in the last six months, the top three standout high-quality Star Stocks were: IPD Education (ASX: IEL), REA Group (ASX: REA) and Aristocrat Leisure (ASX: ALL).