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Lawrence A. Cunningham’s Quality Investing: These 10 stocks have the right stuff that top investors want in their portfolios

It pays to be a quality shareholder. The label, exemplified by famed investor Warren Buffett, refers to investors with long-term investment time horizons and business focus. 

Quality shareholders have a different perspective to a stock than short-term traders and passive index funds do. Indexers are content with pocketing the market return and short-term traders willingly incur trading fees and taxes. But the quality shareholder seeks outsized returns with minimal transaction costs. Such an approach is proven to lead to consistent outperformance.   

It stands to reason: You rarely get rich from doing things which are so easy that anyone can do them. You get rich by doing something different — like being a patient investor.  And why would you want to be like most other people, with their short-term thinking? After all, in a famous study, two-thirds of men and one-quarter of women would rather give themselves electric shocks than quietly sit still.

Passive indexers love sitting still, but since they don’t do any homework, they can’t generate excess returns. Nor are you likely to get rich trying to time the market, buying when the price is low and selling when the price is high. Markets are massive information- and rumor-processing machines. They move unpredictably and often abruptly. That’s why it’s hard to think of any famous successful market timers as a model for investors.

In contrast, quality shareholders, who have compounded investment wealth at high returns over long periods, are legendary. They include such titans as John Maynard Keynes, Peter Lynch, Geraldine Weiss, Warren Buffett, Prem Watsa and Mellody Hobson.

Who are the leading quality shareholders these days, which companies do they like best, and what factors make such shareholders and companies mutually attractive? Answers continue to be developed by the Quality Shareholders Initiative, a research program I have been directing for several years.

To give a sense of the best quality shareholders currently, here are some impressive investment firms at the top of the list:

The best of the quality shareholders

Edgewood Management; Sanders Capital; Eagle Capital; Akre Capital; Cantillon Capital Management; Ruane, Cunniff & Goldfarb; Gardner Russo & Gardner, Southeastern Asset Management.

(Source: IHS-Markit data, selecting for publicly filing funds having the most concentrated portfolios and the lowest rate of portfolio turnover.)  

As for companies that today’s quality shareholders invest in the most, here is a sampling worth a close look:

Companies that attract quality shareholders

Accenture
ACN,
-3.24%

; Thermo Fisher Scientific
TMO,
-1.78%

; Costco Wholesale
COST,
+0.51%

; UnitedHealth Group
UNH,
-2.02%

; Texas Instruments
TXN,
-2.13%

; Ecolab
ECL,
-2.42%

; Roper Technologies
ROP,
-1.53%

; Markel
MKL,
-1.93%

; Danaher
DHR,
+0.59%
,
Credit Acceptance
CACC,
-3.78%
.

(Source: IHS-Markit data, selecting for companies having the greatest number of quality shareholders as identified.)

What do quality shareholders look for in a company, along with outstanding economic prospects? We are sifting through scores of potential factors and finding valuable answers. A few top findings:

1. Quality shareholders favor companies with proven competitive advantages, such as brand strength. They like corporate managers who appreciate the value of this intangible asset and work to reinforce it.

2. Quality shareholders prize CEOs who aim to put every corporate dollar to its best use—a concept called  capital allocation, whether to reinvest in current operations, acquire new businesses, buy back stock or pay dividends.

3. Quality shareholders like to see directors who have skin in the game — those who have a large portion of their net worth in company shares, bought with their own money. These directors are themselves quality shareholders, whose incentives are identically aligned with quality shareholders.  

Being a quality shareholder is not easy, but is rewarding. The temperament needed to be focused and patient pays off if you have it.

Lawrence A. Cunningham is a professor at George Washington University, founder of the Quality Shareholders Group, and publisher, since 1997, of “The Essays of Warren Buffett: Lessons for Corporate America.” Cunningham owns shares of Berkshire HathawayFor updates on Cunningham’s research about quality shareholders, sign up here

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Also read: Meet the corporate insiders whose No. 1 job is making sure the money you’ve invested is managed properly

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