Twenty five quality global income stocks

After a painful first two-thirds of 2022, the 24 months since have set a high bar for stockpickers with a global remit. Since 6 September 2022, the MSCI World Index’s total return is 28 per cent.

The signature explanation for this rally is by now well known. Powered by a fanatical zeal for artificial intelligence (AI), a narrow band of already mammoth US technology shares went on a blistering run, swelling their own value within the US stock market, and the US market’s value within market-weighted global indices. To merely stay relevant, it was assumed global equity allocators would need to buy those stocks. To beat the market, many decided to overweight an already highly concentrated story.

However, it has been possible to better those returns without putting every egg in the basket marked AI. Our Geico screen, which we launched two years ago, is currently ahead of both the MSCI World and the fund on which the screen’s stockpicking methodology is loosely based, Guinness Global Investors’ Global Equity Income (IE00BVYPNY24). So far, it has managed the feat with continuous exposure to just one US tech giant (Microsoft (US:MSFT)) in its 25-stock portfolio.

As a reminder, ‘Geico’ is both a nod to one of Warren Buffett’s all-time favourite long-term investments, and an acronym (Global Equity Income Compounders) that roughly describes the kind of dividend-paying, world-leading and high-return companies that the screen shoots for.

To do this the screen considers every constituent of the MSCI World Index. As a result – and unlike the rest of the screens we follow – this involves multiple stock exchanges and countries. Because overseas shares typically incur withholding taxes that clip the compounding effect of a total return strategy, the methodology’s all-in returns are somewhat notional, even if many large corporates’ preference for buybacks nulls the amount of shareholder returns UK investors must forfeit to tax authorities.

That said, the high multiples attached to many of the stocks means that their yields are lower than more familiar FTSE 100 names. A product of this is that almost all of the screen’s performance to date has come from share price gains, meaning returns could largely have been captured if the stocks were held in a relevant tax wrapper.

Another encouraging feature of the screen has been the consistency of its selections. Ten of last year’s cohort also featured in the inaugural version of the screen, while 14 of this year’s stocks made the 2023 cut (see below). A further three return this year after dropping out in 2023, while eight – Microsoft and fellow Nasdaq constituent MarketAxess (US:MKTX), France’s Hermes (FR:RMS) and L’Oréal (FR:OR), the Frankfurt-listed Nemetschek (DE:NEM) and Rational (DE:RAA), and Hoya (JP:7741) and Zozo (JP:3092) of Japan – have made every refresh.

This, I’d argue, makes the selections closer in spirit to a real-life equity portfolio, where stocks are typically held for longer than a year. It’s especially true of a quality-led investment strategy in which superior corporate attributes and strong market positions tend to act as multipliers over time.

One might therefore argue that two years is too short a time to make many conclusions. Still, it’s worth noting that a portfolio of the eight constant Geico stocks would have produced a 38.9 per cent total return since the screen was launched, with fixed income trading platform developer MarketAxess the sole negative contributor to the portfolio’s returns.

For the second year, 2023’s selections beat both of the screen’s benchmarks, finishing the 12-month period up 20.7 per cent on a total return basis, compared with 18.3 per cent from the MSCI World index and 15.1 per cent from the GEI fund. Highlights included the two German-listed screen mainstays, the four Japanese selections (which produced an average return of 28.9 per cent) and the sole UK constituent, Hargreaves Lansdown (HL.), which finished the year strongly thanks to its proposed private equity takeover. The fact that just three of the 25 selections lost money in the period is also encouraging from a capital preservation perspective.

Methodology

As we have noted, the reappearance of several of last year’s stocks is a feature rather than a bug of this screen. The managers of the Guinness Global Equity Income fund team like to hold stocks for at least three years, making an annual review a decent point to re-evaluate holdings and either ‘sell’ or ‘add’ stocks according to their pass rate.

However, the recurrence of several names is also down to the exacting (or maybe restrictive) nature of the criteria, which are applied annually to the constituents of the MSCI World Index and loosely map the Guinness team’s rules. They are, as follows:

• Returns test: return on common equity of at least 10 per cent a year for the past decade
• Size test: market capitalisation above $1bn
• Leverage test: total debt must not exceed shareholder equity
• Dividend test: must pay one
• Sentiment test: free cash flow forecast to improve over the next two years
• Capital budgeting test: cash return on capital invested (CROCI) in the top quintile of stocks screened
• Valuation test: current price/earnings ratio no more than 20 per cent above the five-year average

While the dividend and free cash flow growth tests are achievable for most, the remainder set a very high bar for even the most successful and largest public equities. As has been the case for the past two years – and is likely to be the case in future years – the requirement to show a ROCE of at least 10 per cent a year for a decade is especially challenging.

Although these tests set the standard, what I particularly like about the methodology is its subtle nod to value. And while a relative measure allows for the possibility of an increasingly expensive valuation, a 20 per cent premium is, I think, sufficiently restrictive as to filter out stocks that have are in danger of slipping into bubble territory. In turn, this offers a critical difference to size-weighted indices, which take an agnostic approach to value.

While that likely means missing out on some of the most spectacular earnings growth stories – such as Nvidia (US:NVDA), which has added more value to the MSCI Index than any other individual stock in the past two years, and just falls outside the top 25 because of its earnings multiple – I can live with that. After all, the Geico screen is trying to solve for genuinely long-term (and therefore sustainable) generators of quality profits.

Below are this year’s stocks in full, as well as a downloadable spreadsheet showing a much wider range of operational and valuation metrics.