Stocks exhibiting these traits are typically a solid mix of quality and momentum. We can see this using the StockRanks: Burberry has a Quality Rank of 97 and a Momentum Rank of 98.
Studies indicate that combining factors such as Value, Quality and Momentum is a more effective way of outperforming the market over longer time frames. That's why we have constructed our StockReports to give an instant impression of how well exposed Burberry (LON:BRBY) is to these three factors. We go into greater detail on factor investing in this video.
Disclaimer: These articles are provided for information purposes only. The content is not intended to be a personal recommendation. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser. The author has no position in the stocks mentioned, unless otherwise stated.
Often the real stock market winners are not the shares that look obviously cheap compared to book value or earnings but are instead the slightly more expensive high quality operators with improving outlooks.
Burberry (LON:BRBY) is one of them. Here's why this might be the case.
Top analysts and investors such as Warren Buffett and Michael Mauboussin say capital allocation - the deployment of company time, money, ideas, and people - is the key to building moat-like quality and profitability characteristics. It is perhaps the most fundamental driver of future share price performance. If you find a company that consistently allocates its capital profitably, chances are you are onto a long-term winner. I think Burberry might be one such company.
Capital allocation - it's harder than it looks
Unfortunately, CEOs are not generally promoted based on their ability to allocate capital, even though this is what they then go on to spend time doing. Buffett sums it up nicely in his 1987 letter to shareholders:
“Most bosses rise to the top because they have excelled in an area such as marketing, production, engineering, administration or, sometimes, institutional politics.
Once they become CEOs, they face new responsibilities. They now must make capital allocation decisions, a critical job that they may have never tackled and that is not easily mastered. To stretch the point, it’s as if the final step for a highly-talented musician was not to perform at Carnegie Hall but instead, to be named Chairman of the Federal Reserve.”
So if you’re only looking at sales and earnings growth, there is a vital question not being considered: how is this growth being funded?
Screening for upwardly mobile, high quality companies
That’s where ratios like return on equity (ROE) come in. ROE measures how efficiently a company uses Shareholders’ Equity to generate profits. It is calculated by dividing net income by book value of equity.
It’s no coincidence that Buffett is a fan of the measure - companies with high ROEs tend to exhibit the high-quality, moat-like business traits that he is so fond of gaining exposure to.
To find high ROE stocks whose fantastic business models are being rewarded by the market, you can create a screen that selects only stocks with both positive one-year relative strength and upgraded current year broker forecasts. The former ensures these shares have been outperforming the market and the latter suggests outperformance can continue.
One of the stocks that currently qualifies for this simple screen is Burberry. The group has: