Last Updated on 9 January 2021 by F.R.Costa
In the light of a widely anticipated economic slowdown it’s time to bend your portfolio towards quality equities. Article originally published at Master Investor Magazine September 2019 Issue 54 p.36-42.
After 10 years rising, equities are becoming a little stretched in valuations and an economic slowdown seems inevitable. While it’s difficult to build a crisis-proof portfolio, it’s possible to tweak portfolio holdings to get better protection for a potential downturn.
It’s not time to write off the equity market, but we need to be cautious, because there are hints of tougher times ahead.
Profitability and quality are the key traits to look for in stocks at a time of rising volatility.
Any individual investor can build a quality portfolio with the help of a good screening. The key idea is to identify the key accounting ratios that are the best proxies for quality. In my exercise, I considered:
- Return on Capital Employed (ROCE) – the higher the better.
- Cash Return on Capital Employed (CROCI) – the higher the better.
- Debt-to-Enterprise Value – the lower the better. We need to make sure the company runs a sound business and won’t be caught off guard during a downturn.
- Interest Cover – the higher the better.
- EBIT Growth Volatility – the lower the better.
There are many other possibilities but I found that the above ratios do a very good job screening quality stocks. The next step is to build an overall ratio from the individual rankings to then select the top stocks and build the portfolio. Again, there are many possibilities here. For a more detailed explanation on how to build a quality portfolio using accounting ratios and rankings, please read my original article published at Master Investor Magazine.