Until a few years ago, General Mills had a strong moat around most of its business lines, including Yoplait Yogurt. Small yogurt companies couldn’t afford national advertising budgets. Today, Jain notes, they can advertise on Facebook.
Disney is another company many people think is poised for several strong years of good results following its acquisition of Fox. Jain isn’t so sure. Certain segments of its business, like broadcasting and cable networks, are no longer growing. Its movie studio business enjoyed a banner year, but it is notoriously mercurial.
The other big worry, in Jain’s view, is what could happen to its giant theme park operations in an economic slowdown. If they keep raising prices at Disney parks, the cost to many young families of four becomes almost prohibitive, he believes.
Finally, there is another issue. No acquirer on the media landscape has been more successful over the last four decades than Rupert Murdoch. Disney investors might want to ask themselves, “Why is Rupert Murdoch selling?” Jain says.
But it is also possible for companies that have fallen out of the quality universe to regain their luster. Microsoft is one prominent example.
Procter & Gamble is another. For years, many considered the Cincinnati-based consumer products giant a victim of the law of large numbers. Most of its product lines like Crest and Ivory soap move in lockstep with GDP and also are subject to pricing pressure. Jain’s team at GQG discovered last year that the company overhauled its incentive package for its sprawling sales force. Lo and behold, sales surprised to the upside, and P&G turned into a winner last year.
Many technology companies populate the low-quality universe. While Hunstad won’t name names, he believes that their lack of profitability will come back to haunt many of these concerns as they revert to their mean. In a number of cases, it is happening already.
Hunstad sees the utility sector as one where earnings stability, the search for income and the perception of quality have caused excessive valuation. Now many utilities’ shares are “far too high to justify,” he says.
Hunstad himself has written extensively on quality investing and worries about some of the misconceptions in the marketplace. “Many firms just look at a return on equity. That’s not enough,” he argues.
A metric like return on assets may be very relevant for analyzing industrial companies and of little use when looking at financials, he explains. His portfolios focus on three themes: a target company’s profitability, its cash flow and its efficient use of capital.