Did you know that in January 2024, there are still investors bagholding Bed, Bath & Beyond, hoping for a turnaround, despite the company filing for bankruptcy in 2023 and getting its stock cancelled in September? That’s right, the stock doesn’t even exist anymore!
It’s a morbidly fascinating, yet cautionary tale of how human psychology can impact investment decisions. Often, the pain of a bad loss can lead investors to make irrational choices, clinging to fading hopes rather than accepting reality.
This scenario underscores a critical lesson in investing: the importance of diversification. By spreading your investments across a variety of stocks, you reduce the risk of being heavily impacted by the poor performance of a single company.
One effective strategy is to focus on key financial metrics that indicate high-quality stocks. These metrics can guide you in selecting companies that have strong fundamentals and are more likely to provide stable returns over the long term.
Additionally, for those who prefer a more hands-off approach or are just starting their investment journey, there’s an ETF that encapsulates this strategy, effectively doing the heavy lifting for you.
Quality metrics to use
When it comes to selecting high-quality stocks, I like focusing on just a few financial metrics. The three I like are high return on equity (ROE), stable year-over-year earnings growth, and low financial leverage.
ROE measures how effectively a company is using the money invested in it by shareholders to generate profits. Think of it like this: if you were to invest $100 in a company, and that company made a profit of $10 from your $100 in a year, then the ROE would be 10%.
A high ROE indicates that the company is efficient at generating profits from its equity. When looking for quality stocks, a consistently high ROE over several years can be a good sign.
A pattern of stable earnings growth is another crucial metric. It looks at how much a company’s earnings (or profits) have grown from one year to the next. Consistent growth in earnings is typically a sign of a company’s good health and ability to increase profits over time.
For instance, if a company’s earnings grow steadily by, say, 5% every year, it suggests a reliable growth pattern, which is often a positive indicator for investors.
Finally, look for low financial leverage, referring to the level of a company’s debt compared to its equity. Financial leverage is like using a loan to boost your business. While some debt is normal, too much can be risky, especially if the company’s earnings start to fall and margins begin to narrow
You can assess this by looking at the company’s debt-to-equity ratio; a lower ratio suggests less reliance on debt. In general, low financial leverage means the company isn’t overly dependent on debt, which can be safer for investors.
An ETF that does it all
BMO MSCI All Country World High Quality Index ETF (TSX: ZGQ) is a comprehensive solution for investors looking to incorporate high-quality stocks into their portfolio without the hassle of individual stock picking.
ZGQ does the heavy lifting by screening global stocks based on the key quality metrics of high return on equity, stable year-over-year earnings growth, and low financial leverage.
What makes ZGQ particularly appealing is its approach to diversification. The ETF caps each stock in its portfolio at 5%, ensuring that no single company dominates the investment.
For investors, this means instead of meticulously researching and buying a dozen or more individual stocks to achieve a diversified, high-quality portfolio, you can simply invest in ZGQ. With this single ticker, you get access to a portfolio of over 500 quality stocks from around the world.
