Whether shopping for clothes, furniture, or a ribeye steak, quality matters. The same goes for stock investing.
When building a long-term portfolio, investors need to find companies that can withstand the test of time. Being part of an industry that will be around for a while and having solid fundamentals are a good start.
How we define quality is rather subjective. Everyone seems to have their own criteria that filters out the best of the best. The hundreds of quality-focused mutual funds and ETFs even have differing approaches. Some use quantitative tools based on profitability, others emphasize the balance sheet or even the management team.
S&P Global Market Intelligence leans on fundamental data to assess quality. Using information from all three financial statements, it comes up with an overall rating of a company’s earnings quality relative to its peers. The sector-sensitive score ranges from 1 to 100, with 100 being the highest quality companies.
Let’s focus on the U.S. mid-cap space in sampling some of what S&P GMI considers to be high quality names built for the long-term.
What Makes Whiting Petroleum a Quality Stock?
Whiting Petroleum Corp. (NYSE: WLL) boasts a quality score of 99 which puts it at the top of the energy sector. The oil and gas producer has returned to profitability with a vengeance thanks to rising commodity prices and increased production levels. After recording a steep loss in 2020, last year’s EPS consistently beat consensus estimates. The result: a 159% return for the stock.
Investors have continued to pour money into Whiting Petroleum shares this year sending it an extra 28% higher. While this has had much to do with the impact of the Russia-Ukraine conflict on energy prices, it’s also a testament to the company’s stature in the mid-cap E&P space.
Whiting Petroleum’s quality label is based on both its earnings and cash flow. Last quarter’s adjusted net income of $293 million was higher than the reported figure. This is the preferred scenario as opposed to when certain one-off items artificially boost reported earnings.
Meanwhile, operating cash flow continued to improve during the period which confirmed that earnings are being supported by strong cash flow. This is why many investors prefer cash flow over earnings as the best measure of a company’s performance.
Does Teradata Have Good Fundamental Quality?
Teradata Corp. (NYSE: TDC) also has S&P GMI’s coveted 99 quality rating, which distinguishes it as a technology sector leader. The provider of cloud-based analytics software generated approximately three-fourths of its 2021 revenue from recurring subscriptions. This is a transparent business model that many tech investors find attractive and one that supports Teradata’s high quality ranking.
When comparing Teradata’s reported earnings to its adjusted earnings, the result is favorable. For the trailing 12 months, adjusted earnings were 153% of reported net income. This is a figure that has trended upward in recent years and repeatedly been well above 100%. In Q4, net income nearly doubled to $33 million as more customers migrated to the Vantage cloud and recurring subscriptions became a bigger part of the revenue mix.
Another way to measure quality is to compare a company’s earnings to its operating cash flow. A high proportion of operating cash flow to earnings is preferable and will often drive a high-quality score. In 2021, Teradata’s operating cash flow represented 315% of earnings, a very high ratio that screams fundamental quality.
Is Ryder System a Good Stock?
Transportation and logistics leader Ryder System, Inc. (NYSE:R) is also a leader when it comes to industry fundamentals. It has a S&P GMI quality score of 96, which speaks to the strength of its income and cash flow statements. No other trucking business at any market capitalization scores higher.
Last quarter Ryder’s EPS easily topped Street expectations for the fourth straight quarter. The pickup in economic activity, improved freight market, and better pricing added up to a strong bottom line performance. Yet it is the robust cash flow that is largely responsible for why Ryder rises to the top of the quality scale.
With cash flow, it is the recurring variety or cash flow that is derived from operations (rather than financing or investing activities) that matter. Ryder’s adjusted operating cash flow to reported operating cash flow has been in the 87% to 90% range the last few years, which tells us that the potential for financial shenanigans is small. Some investors deem cash flow to be the more reliable performance indicator because it is less prone to accounting tricks and manipulation.
Besides its quality attributes, Ryder is an appealing long-term investment on account of its shareholder friendly management team. Last month, the company announced a $300 million accelerated buyback program to go along with the stock’s 2.8% dividend yield. Quality fundamentals and quality management should keep Ryder’s stock price trucking higher over the long haul.
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