Quality investing is a strategy that focuses on buying the best companies the stock market has to offer. We are talking financially healthy companies with durable competitive advantages, strong balance sheets and reliable cash flows. Additional markers of quality include high margins and track records of reliably generating profitable growth.
When it comes to investing in quality, the goal is to identify resilient businesses that can compound wealth over time and weather economic downturns. Quality investors avoid chasing short-term share price momentum or buying shares trading at bargain-basement valuations in the hope they’ll eventually re-rate.
While quality-focused investors don’t ignore valuations altogether, they accept they’ll often have to pay a premium for quality.
In this article, we explain how top fund managers define ‘quality’ and why the style is overdue a return to form. We also highlight six high-quality companies that professionals managers are big fans of. This cohort has the potential help grow portfolio profits over time, but readers should do their own research before pressing the buy button.
Quality investing in a nutshell
Rather than trying to predict every twist and turn in the economy, the quality approach seeks out companies with solid foundations that should be able to stand the test of time.
Generally speaking, high-quality companies generate steady cash flow. Typically, they have low levels of debt on their balance sheets and they consistently earn high returns on the capital they invest.
Renowned quality investors include Warren Buffett, whose approach evolved from buying cheap ‘cigar butt’ stocks to purchasing high-quality companies with economic ‘moats’.
As Buffett’s late business partner Charlie Munger once opined: ‘Over the long term, it’s hard for a stock to earn a much better return than the business which underlies it earns.’ British fund managers who pursue a quality growth approach include Terry Smith and Nick Train.
Can quality bounce back?
The quality style gained particular popularity during the period of ultra‑low interest rates that ran from the end of the Great Financial Crisis until about 2020. With bond yields low and economic growth subdued, investors tended to favour companies seen as dependable and relatively resilient.
But the backdrop has shifted significantly since the pandemic. Rising inflation and higher interest rates helped areas of the market that had been unloved for years, often labelled ‘value’ stocks. Investors rotated into more cyclical sectors, many of which sit at the opposite end of the quality spectrum.
In recent years, the quality investing style has faced another headwind. Hype surrounding AI-related stocks and investors’ enthusiasm for speculative growth and momentum stocks has driven markets higher while leaving many quality stocks behind.
With quality investing out of favour, Terry Smith’s Fundsmith Equity Fund (B41YBW7) has materially underperformed the MSCI World Index over the last three and five years. Nick Train’s Finsbury Growth & Income Trust (LON:FGT) has also endured a long spell of underperformance.
Train is sticking to his disciplined, long-term approach focused on high-quality businesses with resilient franchises and hard-to-replicate data assets, where we believes AI will enhance value rather than destroy it.
Quality on sale
Eric Burns manages TM SDL UK Buffettology (BF0LDZ3), the fund which follows the principles of Warren Buffett. Under Burns’ stewardship, Buffettology pursues a Business Perspective Investing approach that puts quality first, then considers valuation.
Burns tells Sharesify that UK quality is at a cyclical low versus value. And he argues this has created a compelling entry point for investors. ‘Growth has never been as cheap relative to value since 2013,’ he insists.
‘I think that the rates backdrop over the next five years will be a lot more favourable than we’ve seen over the previous five years,’ says Burns. ‘And if the general economy gets harder, you want to be holding business with strong balance sheets that have seen a cyclical downturn before. In Buffettology, we have such businesses in abundance. When you get a shakeout in the economic cycle, it’s the stronger businesses that get stronger and the weaker players, the businesses without the moats, get hammered the most.’
James Harries manages STS Global Income & Growth Trust (LON:STS), a global equity income trust focused on quality companies in an uncertain world. ‘Our view is that while the excitement of AI is going on, there are a lot of high-quality assets being left by the wayside,’ Harries tells Sharesify.
‘In our experience, you shouldn’t try and short the most exciting stock and go long the cheapest stock. Often the thing that’s most interesting is the thing that’s been forgotten about,’ he observes.
Metrics managers look for
Quality investors screen for metrics including the return on equity or ROE, which measures after tax profit as a percentage of shareholders’ equity. A sustainably high ROE tends to indicate the existence of an economic moat. In the same way a moat around a castle helped to keep out attackers, an economic moat enables a business to maintain high returns on equity. It prevents competitors from eroding a quality company’s economic advantages.
Another popular metric is return on capital employed or ROCE. This is a measure of the ability of a company to deliver profits to all its providers of capital, including debt financing. Meanwhile, the return on invested capital or ROIC measures how efficiently a company allocates its capital to generate those profits.
High-quality companies tend to have low amounts of debt to run their operations. This makes them more robust during periods of rising interest rates and less sensitive to economic downturns. Quality companies also tend to have smooth, predictable earnings. And they convert a healthy amount of earnings per share into free cash flow. Free cash flow is the cash left over after the expenses and investments required to maintain a company’s competitiveness.
ROE & cash return
When it comes to identifying quality, Buffettology’s Burns puts great store in the ROE. ‘The reason for that is we are equity owners, so it’s that return that matters the most to us. And we use average equity, we smooth it over the year to get an average equity base to generate the metric.’
In terms of the fund’s portfolio fundamentals, Buffettology has an average ROE that is well into the forties percentage-wise. ‘But there is a bit of a skew because we hold Rightmove (LON:RMV), and Rightmove has an embarrassingly high return on equity of 200-and-odd percent. Even stripping that out, we are talking ROE in the 30s.’
For Burns, the second-highest quality metric in terms of importance is a company’s cash return. ‘There is a difference between accounting earnings and the cash that businesses generate. So the other thing that we track very closely is cash conversion. In an ideal world we would like 100% cash conversion. But we are well into the 80s with that. It is actually cash that can be used to fund dividends, share buybacks, M&A or reinvestment into the business.’
Burns adds: ‘You would expect businesses operating at the quality end of the spectrum to be higher-margin businesses than the market as a whole. And we also want businesses that are growing.’
Six quality stocks to consider
Harries has recently purchased a trio of high-quality businesses for STS Global Income & Growth. These are luxury goods giant LVMH (EPA:MC), ticketing platform CTS Eventim (ETR:EVD) and French toll road business Vinci (EPA:DG).
‘LVMH has had a really tough time,’ says Harries. ‘But the thing about LVMH is it is ultimately predicated on the human desire to show off. And that isn’t going to go away. People are keen to pay over the odds for LVMH’s products because they denote wealth. And this bakes in a really attractive gross margin and profitability.’
From a quality perspective, Harries finds LVMH’s high returns on capital and the fact it is nicely diversified by geography and brand reassuring. ‘Because of weakness in China, the Middle East conflict and concerns related to travel, LVMH has come down to a pretty attractive valuation. And we’ve begun to establish a position for the first time in a very long time’, he explains.
Turning to Vinci, Harries says the toll road gives investors certainty of cash flow, which ameliorates the cyclicality of the construction business. ‘And that gives you upside to this building dynamic that we expect to unfold in the coming years’.
CTS Eventim is Europe’s dominant ticketing platform. Harries insists network effects for this business are powerful. ‘More venues and promoters want the platform with the most buyers. And more buyers go where the inventory is. Further, accumulated proprietary data enables targeted marketing, increasing the likelihood of strong ticket sales for artists and venues. These represent powerful competitive advantages.’
High conviction in Halma
Alexandra Jackson manages the Rathbone UK Opportunities Fund (B7FQM50). She highlights Halma (LON:HLMA) as ‘one of our highest-conviction holdings for many years’. The safety and health care group remains ‘a good example of the quality characteristics we seek in businesses’. Halma also has the ability to compound earnings at attractive rates through multiple economic cycles, according to Jackson.
She says Halma’s decentralised operating model gives individual companies the freedom to innovate and respond to customers. It also allows them to benefit from the group’s capital, expertise and culture.
‘The financial results show that this culture is a genuine competitive advantage, along with a strong focus on succession planning, knowledge sharing and disciplined capital allocation,’ insists Jackson. ‘Together, these attributes have helped Halma deliver remarkably consistent organic growth of around 6% to 7% over the past decade, resilient margins and attractive returns over long periods.’
| Halma | Share price: £35.14 |
| Market cap: £13.6bn | FY26 ROE: 18.3 |
Source: Stockopedia
Recent share price weakness reflects concerns that growth in Photonics, Halma’s AI-related business, may be slowing after an exceptional period. However, Jackson thinks the market has overreacted. ‘Management attributed the moderation in growth expectations to supply constraints rather than weaker demand, while wider industry investment in AI infrastructure remains robust,’ she explains.
‘Importantly, Halma has a long history of conservative guidance and upgrading throughout the year. Ahead of this update we had reduced our holding by 25%, cognisant that even tall trees don’t grow to the sky. While the photonics division has undoubtedly attracted a new cohort of AI-focused investors, we continue to see it as an enhancement of the investment case rather than the bedrock. Management are using the premium cashflow generated by this division to reinvest in the rest of the business, another quality marker.’
Games Workshop has quality at its core
At last count, fantasy miniatures maker Games Workshop (LON:GAW) was the biggest holding in the Buffettology Fund, representing 9.34% of assets. And with good reason. The Nottingham-based company behind the Warhammer hobby is a high quality, cash generative business with global growth potential.
Investors are particularly excited by the FTSE 100 company’s partnership with Amazon (NASDAQ:AMZN) to create films and television set in the Warhammer universe. Revenue and pre-tax profits reached record levels in the year to May 2026 thanks to another good performance from the core business. And the gross margin expanded from 69.5% to a formidable 71.1%.
| Games Workshop | Share price: £196.40 |
| Market cap: £6.7bn | FY26 Gross margin: 71.1% |
Source: Stockopedia, preliminary results
‘Games Workshop’s ROE is in the low-70s. And the five-year average of free cash flow over normalised earnings, which is the proxy we use for cash conversion, is 92%,’ says Burns.
His channel checks suggest the recent launch of the 11th edition of Warhammer 40k has been one of the most popular yet. ‘People that play the hobby are bought-into the whole ecosystem,’ enthuses Burns.
‘That is Games Workshop’s moat really. And we’ve observed that Games Workshop is very, very protective of its intellectual property (IP). The company is very strict on how its characters are used, everything needs to be licensed and approved. That is vitally important as the intellectual property is Games Workshop’s main asset.’
Why Softcat stands out
Imran Sattar, manager of Edinburgh Investment Trust (LON:EDIN), is a fan of Softcat (LON:SCT), the UK’s leading value-added reseller of IT infrastructure and services. The group supports over 10,000 customers across the corporate and public sectors. FTSE 250-listed Softcat provides software, hardware and services through relationships with more than 400 technology vendors.
‘Softcat stands out as a quality business because it consistently combines high returns on capital, excellent cash conversion and disciplined capital allocation,’ says Sattar. ‘Its asset-light model requires little incremental capital to grow, enabling the business to convert a high proportion of earnings into free cash flow while returning excess cash to shareholders through ordinary and special dividends and more recently a share buyback.’
Softcat has delivered mid-teens profit growth per annum over the past decade, notes Sattar. ‘This has been driven by steady customer growth and more than 10% annual growth in gross profit per employee. Recent concerns around weaker IT spending and AI-driven disintermediation created an attractive entry point. In our view, the market is underestimating the durability of Softcat’s growth, the resilience of its business model and its ability to continue compounding earnings growth over the long term.’
| Softcat | Share price: £19.72 |
| Market cap: £3.8bn | FY25 ROE: 41.8 |
Source: Stockopedia
Rebecca Maclean is co-manager of investment trust Dunedin Income Growth (LON:DIG), which also has a holding in Softcat. ‘Across the five pillars of quality that we assess, Softcat stands out,’ insists Maclean. ‘Its competitive advantage stems from a distinctive culture, broad vendor relationships and a strong reputation as a trusted technology partner. Financially, its asset-light business model generates high returns on capital and strong cash conversion, supporting both reinvestment and dividend growth.’
From a sustainability perspective, Maclean believes Softcat’s people are its key differentiator, helping attract talent, deliver high levels of customer service and build enduring client relationships.
‘Finally, management has demonstrated disciplined capital allocation throughout the company’s growth journey,’ stresses Maclean. ‘Together, these qualities have underpinned a strong record of both income and capital growth. This makes Softcat what we believe to be an exemplary holding for Dunedin Income Growth.’
