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In part 2 of his “Rapid Fire Questions”, equity strategist Philip Brooks shares his views on 3 key questions, focusing on the topic of Quality and investible opportunities today in US and abroad.
Question: How do you evaluate Quality in the Quality Growth Platform?
In the quality growth portfolios, our definition of quality is linked to the financial quality of the companies that we invest in. And specifically, the level of free cash flow generation that that company is able to maintain over time, that is, for every dollar of revenue that the company makes after all of the costs of their business, including reinvestment needs, how much of that revenue is left over at the end of the day to potentially return to shareholders
Now, that is why free cash flow generation is important. More free cash flow available to return to shareholders, ultimately drives the share price performance of a company. In general over time, the higher level of free cash flow generation, the stronger that company is, in terms of its likelihood of outperforming the broader market and its peers.
Question: What are the interesting opportunities today in the US equity market?
In the last couple of years many of those opportunities have been focused in the IT sector and companies such as the Magnificent Seven. But more recently, following that period of very strong outperformance.
In a number of cases, these companies, while they're still great companies, they're not as attractive to us as stocks given their high levels of valuation. Essentially, their future returns may not today be as strong as their past returns.
And so you've seen in our portfolios, we've been reducing exposure in the IT sector over recent months in the portfolio. And increasingly, we're finding opportunities outside of the IT sector. In particular, I would highlight in the financial sector, we're seeing some strong opportunities in payments businesses and asset management firms. To a smaller degree, less so in banks. But in non-bank financials, we see opportunities as being very attractive today
I would also mention that we're increasingly seeing opportunities in the energy sector in the US. And today we're finding some very interesting opportunities in US natural gas companies. These are companies that today are generating much higher levels of free cash flow than they've done in the past, and they're also benefiting from significant demand growth from end customers, both in the US but also very importantly in Europe where there's been a significant increase of imports of US energy.
Question: What are the interesting opportunities outside of the US?
In non-US markets, we're finding companies across a range of countries and sectors with a much better combination of both quality, but also upside valuation. Certainly traditionally health care companies have been a very strong source of opportunity in Europe. And that continues to be the case today. But in other sectors, I would highlight industrials.
Now in the industrial space in Europe, defense companies have been and continue to be today a very attractive investment opportunity in the market and similarly also in industrials, logistics and trucking companies in Europe are also offering really interesting opportunities today.
In other parts of the world, we're also seeing strong opportunities in Japan, driven by the corporate reforms that we're seeing companies unwinding cross shareholdings, and increasingly returning capital to their shareholders. That's making many Japanese companies today, quite a lot more attractive than we've typically found them to be in the past. We're also seeing opportunities across emerging markets, and in particular, in China. And we continue to see a range of very innovative businesses in China with very strong forward return potential.
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