SPHQ: Quality Stocks According To S&P Global

Introduction

I consider myself a growth at a reasonable price and value investor. I have developed processes that have been successful for me over two decades. I studied works by John Reese, was mentored by the late Ken Kam, and often I to talk to my dear friend Harry. Harry is the savviest investor I know, and I occasionally share his insights. I am quite confident in my abilities as an investor, but I fully understand that many people do not have the time to pore over balance sheets to find investing opportunities that might yield a market-beating return.

It is important to understand that some people wish to invest in individual securities, but often do not understand what factors are necessary to find winning stocks. The good news is that companies such as S&P Global have a few good ideas that exist in the public domain.

S&P Global’s Best Large Cap Index

S&P Global has several indices that have developed over the past couple of decades, and there is one that has outperformed the overall broad market S&P 500 Index. It is the S&P 500 Quality Index. Their approach is the focus on Return on Equity, Accruals Ratio, and Debt Ratios. Using statistical measures like Z-Scores to normalize the data, they winnow the S&P 500 universe to the 100 stocks that best meet their criteria. The index started in 2014. The index also rebalances semi-annually. If one is a math jockey, they can read about S&P Global’s methodology, if they choose.

As of the end of last year, these are the top ten components in the index. As a side note, these companies would make a decent large-cap portfolio for any investor.

• Broadcom Inc. (AVGO)
• NVIDIA Corporation (NVDA)
• Alphabet Inc. (GOOG)
• Mastercard Incorporated. (MA)
• Microsoft Corporation (MSFT)
• Apple Inc. (AAPL)
• Visa Inc. (V)
• Exxon Mobil Corporation (XOM)
• Johnson & Johnson (JNJ)
• The Procter & Gamble Company (PG)

Performance

The S&P 500 Quality Index has outperformed the S&P 500 consistently since 1995. Its return of 13.30% outstrips the S&P 500’s return of 10.47% by 283 basis points.

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What I find compelling about this data is that the index outperforms the overall index during up markets and down markets. That is rare for any index and gives this approach some promise. Additionally, the risk metrics show that this index is a better option than the S&P 500. These include the Sharpe Ratio (0.67 v. 0.53), the Sortino Ratio (0.85 v. 0.69), and the Return/Risk Ratio (0.74 v. 0.53). As a disclosure, the returns for the period before 2014 are hypothetical and are based on research from S&P Global and hypothetical returns from Morningstar.

Investing in The S&P 500 Quality Index

Invesco offers an ETF that tracks the Quality Index. The Invesco S&P 500 Quality Index ETF (SPHQ) invests at least 90% of its underlying assets in the index. This is how the ETF compares to SPDR S&P 500 Trust (SPY) using rolling 12-month periods since 2016. While the ETF has existed since 2006, the data is limited to the period when they adopted the Quality Index as their underlying method.

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As one can see, there is a bit of underperformance with the ETF (13.09% v. 13.56%) since the ETF adopted the Quality Index as its methodology. One can also take note of the more recent return data where SPHQ has been outperforming SPY in the last five years. Based on this data, it took a couple of years for the new methodology to correlate with the underlying index. It should be noted that Morningstar did not consider the methodological changes in its rating for SPHQ.

SPHQ maintains an affordable expense ratio (0.15%) and does pay a decent yield of 1.41% which is comparable to its historical yield of 1.48%. Here are some investment ratings for SPHQ:

• Morningstar (Strong Buy)
• Zacks (Hold)
• The Street (Buy)
• Lipper Leaders (Strong Buy)

My Take

I am not a fan of indexing through ETFs or mutual funds. In my core, I like having a more targeted approach to investing. That is why I pick individual stocks. By looking at the S&P 500 Quality Index, I am emboldened that there are metrics that show a tendency to outperform the overall market. I have initial concerns about the underperformance relative to SPY since the new methodology was adopted, but as I wrote earlier, the last five years have been promising.

What I particularly like about this approach is the focus on strong balance sheets, which is where I always look first when I study individual stocks. I also like the complete transparency in the approach the management team has initiated for this fund. SPHQ is a very promising investment for those who want quality to be part of their investment strategy.

Good luck and have fun.