Advertisement

Quality stocks are significantly cheaper in the last 20 years — here’s why

Yahoo Finance’s Brian Sozzi breaks down why quality stocks have been significantly cheaper in the last 20 years.

Video transcript

[MUSIC PLAYING]

MYLES UDLAND: All right, welcome back to Yahoo Finance Live on this Wednesday morning. Earlier than normal in today's program, we're going to get to Brian Sozzi's take. And Sozzi really piggybacks off something we were just discussing as it relates to the fundamentals of the meme trade, which is how quality stocks are lining up in this market. And two parts here. One, by your work, they haven't been this cheap in 20 years, but two, how exactly are we defining quality names in this kind of environment?

BRIAN SOZZI: Yeah, first, we have to-- you're right, Myles. Let's set out what in the world is a high quality stock, because if you're out there trading, you may think the stock you're buying is high quality, even though that company might be losing billions of dollars a year. So, anyway, BlackRock's CEO, Tony DeSpirito, defining what a high quality stock is in a new note I read that came across the wires yesterday.

He's [INAUDIBLE] high quality stocks are one of those companies that generate profits and have pricing power. Always two good things to have if you're a public company. And then next, these companies manage their balance sheets and cash flows effectively. In non-financial industry gibberish, that means you are in such a good position financially that you may hike your dividend, you may announce a new big, large giant share repurchase program that pumps up your stock price that benefits executives and the like.

Nonetheless, that's what defines high quality stocks. And DeSpirito noting that high quality stocks are trading at their largest valuation discount to the broad market since the dotcom bubble of the early 2000. Very interesting, you can see that chart right there on the screen that our nifty production team whipped up for us here. So, that discount is very strong.

Why is it happen? DeSpirito noting that the discount got worse when we got the vaccine announcement back in November of last year. That's where you saw the rotation into some high beta names, perhaps more risky companies, by the like, let's say of the cruise lines. As investors tried to play the economic recovery, forgot about high quality stocks.

But DeSpirito now suggesting you could see a rotation back into high quality stocks as the economy goes into a different cycle. It's recovering, but not at the same pace as it was. And some high quality companies could be positioned to raise their dividends and likely go back and repurchase their stock prices.

And I'll even add this too as well. And you can see how the performance has differed in recent months here. I looked at the Invesco S&P 500 high beta ETF. This ETF contains very risky companies, like a Carnival Corp, United Airlines, very tethered to the economic rebound.

That ETF is up 31% year to date. By comparison, the Schwab US Dividend Equity ETF, that is only up 17% on the year. That ETF happens to house high quality companies, at least in my view, of the likes of a Home Depot and many others.

Now, moving forward here, you could see essentially that my take is basically, embrace value stocks. Embrace high quality stocks. It's time to give these stocks a big giant hug. That is the bottom line here.

You can see dividends increase. You can see share repurchases increase. And high quality companies will tend to get a lot better as the recovery strengthens. Julie, just give them a hug. Just give them a hug.

JULIE HYMAN: [CHUCKLES]

I think they'll be all right. Do they?

BRIAN SOZZI: They need it.

MYLES UDLAND: I think--

BRIAN SOZZI: They've been down and out.

MYLES UDLAND: I think value stocks have gotten plenty of comfort over the last--

BRIAN SOZZI: Give them an embrace.

MYLES UDLAND: --couple months--

BRIAN SOZZI: Just hug them, Myles.

MYLES UDLAND: --couple months or so. Sozzi, it is-- as you mentioned, it is always-- it is always nice to see folks outline what a quality stock is, and it comes back to like the three most basic things you learn in the first day of Finance class, or in Business school, or of course, any intelligent investor. And then really the debate is, are we supposed to define quality stocks that way? Should we not just look at the free cash flow the way that Jeff Bezos has taught a generation of leaders to do?

But certainly, some questions here about what the next driver is for the markets, particularly some of those growth year tech names seem to be picking up some of the baton. Are they quality? Are they not quality? Is that going to last? But just a shocking chart there, I think, to show the way that, at least by BlackRock's work the way quality has been defined, has been out of favor now and falling for quite some time.