Quality suddenly matters a great deal to investors. And ETFs can help raise your standards when choosing stocks.
Shares of 12 stocks in the iShares MSCI USA Quality Factor ETF, including Nvidia, Meta Platforms and West Pharmaceuticals, soared 20% or more this year so far, says an Investor's Business Daily analysis of data from S&P Global Market Intelligence and MarketSmith. That's especially impressive if you consider the S&P 500 is only up 6.7% going into April 13.
And it's not just the quality stocks owned by this popular ETF that are soaring. Money is also pouring into the ETF itself. "The iShares MSCI USA Quality Factor ETF pulled in more money than any ETF in the first three months of 2023 — $7.2 billion — even as industrywide U.S. equity ETFs had net outflows," said Todd Rosenbluth, head of research at VettaFi.
Why is quality suddenly so popular with investors?
Going For Quality
Quality is shoving aside smaller, more speculative stocks as investors seek safety. Fears of bank failures reminded investors of the value of companies with lasting power.
To that end, the $27 billion in assets iShares MSCI USA Quality Factor ETF targets stocks in the MSCI USA Sector Neutral Quality Index. This index includes U.S. stocks that score high in areas typically associated with quality, including elevated return on equity (ROE), low use of debt and highly stable earnings. The ETF is up 8.5% this year.
Nvidia, a designer of high-performance computer chips, is the top performing stock in the index. Shares are up more than 80% this year as investors see Nvidia chips are perfectly suited to handle the demands of new AI tools. The company's ROE is a sky-high 17.9%, meaning it drives nearly 18 cents of profit out of every dollar of investors' money. That's more than double the ROE of rival Intel.
Nvidia does carry debt, but its earnings rose every year from 2017 through 2021. Earnings dropped in 2022 and are seen falling again in 2023, but expected to rise again by 256% in 2024. Nvidia holds a 4% weight in the portfolio. But the tech giant's influence in the ETF is tempered against other sectors, including stalwart financials. "Information technology is the largest sector (23% of assets) but is soon followed by financials (16%). Visa and Mastercard, which recently became classified as financials, are two such top 10 holdings in QUAL," Rosenbluth said.
Other Definitions Of Quality
Quality is in the eye of the beholder with stocks. Not surprisingly, other ETFs take a different approach to quality.
The $13.1 billion-in-assets Pacer US Cash Cows 100 ETF targets the 100 stocks in the Russell 1000 that generate the most free cash flow. This is a measure of cash profits the company is free to deploy, including for dividends and stock buybacks. Not surprisingly, this definition of quality tilts to the energy sector.
"Energy (36% of assets) and health care (19%) are well represented in COWZ through companies like Occidental Petroleum and McKesson," Rosenbluth found. The ETF is up just 2.9% this year.
And yet another approach to quality is the one deployed by Invesco S&P 500 Quality ETF, with nearly $5 billion in assets. The ETF owns companies with high ROE, low debt and high cash earnings compared to reported profit. "The ETF pulled in approximately $750 million of new money to start 2023. SPHQ has more information technology (29% of assets) exposure than its peers, led by Apple and Microsoft, but energy is a healthy 13% stake too," Rosenbluth said. The ETF is up 7.4% this year.
So results by the quality ETFs may vary. But quality itself is in. "Many investors turned to ETFs that invest in higher quality companies with strong financial profiles such as low debt leverage, consistent earnings, and ample free cash flow generation," Rosenbluth said.
Go For Quality
Top-performing stocks in the iShares MSCI USA Quality Factor ETF this year
| Company | Ticker | YTD | Sector |
|---|---|---|---|
| Nvidia | 81.3% | Information Technology | |
| Meta Platforms | 77.9% | Communication Services | |
| West Pharmaceutical Services | 52.6% | Health Care | |
| Arista Networks | 32.9% | Information Technology | |
| Monolithic Power Systems | 32.7% | Information Technology | |
| Cadence Design Systems | 32.2% | Information Technology | |
| PulteGroup | 31.0% | Consumer Discretionary | |
| Masimo | 29.4% | Health Care | |
| Copart | 24.8% | Industrials | |
| Apple | 23.2% | Information Technology | |
| NVR | 21.3% | Consumer Discretionary | |
| MarketAxess Holdings | 21.3% | Financials |
Sources: VettaFi, S&P Global Market Intelligence, IBD
Follow Matt Krantz on Twitter @mattkrantz
