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The benefits high-quality stocks can add to portfolios

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The views expressed in these posts are those of the authors and are current only through the date stated. These views are subject to change at any time based upon market or other conditions, and Eaton Vance disclaims any responsibility to update such views. These views may not be relied upon as investment advice and, because investment decisions for Eaton Vance are based on many factors, may not be relied upon as an indication of trading intent on behalf of any Eaton Vance fund. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. Past performance is no guarantee of future results.

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      By Atlanta Capital Portfolio Management Team

      Atlanta - The strong markets over the past 10 years have been led by lower-quality companies. Within the Russell 3000® Index, lower quality stocks outperformed the broad benchmark by 0.6% per year in annualized total return for the 10 years ended Dec. 31, 2018, based on S&P Earnings and Dividend Quality Rank (see chart disclosure). Conversely, high quality stocks trailed the Russell 3000 by almost 1% per year over the same period. (The Russell 3000® Index includes the largest 3000 U.S. stocks, representing approximately 98% of the investable US equity market.)

      But as noted in Atlanta Capital's Quarterly Quality Scorecard (see below, and link at bottom), quality has been making a comeback: During the trailing one, three and five years, the high-quality stocks in the Russell 3000® have outperformed the broad benchmark by 2.8%, 1.3% and 1.3%, respectively, through December 31, 2018. The performance reflects Atlanta Capital's hypothetical high- and low-quality research portfolios, which compare the aggregate of all companies within the Russell 3000® Index with above average S&P Quality Rankings (B+ or Better) to the performance of the Index itself.

      High-quality stocks have begun to outperform the broad market in recent periods.

      Performance of high-quality stocks within the Russell 3000 Index relative to the Index through 12/31/18.


      While there is no one standard definition of quality, Atlanta Capital focuses on companies with a demonstrated history of consistent earnings and dividend growth over the long term. These companies typically have in common strong financials, healthy margins, the ability to fund growth with cash flow and lower leverage relative to lower-quality firms. In our view, high-quality companies are those that have achieved a sustainable competitive advantage.

      For investors contemplating what the next 10 years holds for equities, we believe it is valuable to consider the historical relationship between high- and low-quality stocks. It's worth recalling that the unprecedented low-rate environment of past 10 years has made it easier for low-quality companies to access capital and helped fuel their performance.

      A longer-term perspective, stretching 40 years over many market cycles, tells a different story. Over the 40-year period ending June 30, 2019, high-quality stocks have outperformed low-quality - not just in absolute return, but with significantly lower volatility as well. Over that period, the high-quality portion of the Russell 3000® Index had an annualized total return of 13.7% versus 9.9% for the low-quality Russell 3000® constituents. Over that period, the standard deviation (a common measure of volatility) of high-quality stocks' was markedly lower - 13.7% vs. 18.0%.

      It is always hazardous to call the "turn" in the market, but the recent outperformance by high-quality stocks is a reminder of the historical advantage they have had over the long term, especially in volatile environments.

      Bottom line: Atlanta Capital believes that investing in high-quality stocks is an important component of prudent investment plans, given the impressive historical return and risk characteristics they have demonstrated over the long term. This blog will continue to offer perspective on relative performance and the factors that drive the results.

      Investing involves risk including the risk of loss. The value of equity securities is sensitive to stock market volatility. Smaller companies are generally subject to greater price fluctuations, limited liquidity, higher transaction costs and higher investment risk than larger, more established companies.