What is "Quality" Investing?
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Visit us at pgm.com forward slash ETFs. This is Barron's Live. Each week, we bring you live conversations from our newsrooms about what's moving the market right now. On this podcast, we take you inside those conversations, the stories, the ideas, and the stocks to watch so you can invest smarter. Now, let's dial in.

Hello, everyone, and welcome to Barron's Live, our daily webcast and podcast. I'm Lauren Rubin, Senior Managing Editor at Barron's. Thanks for joining us today to learn more about stocks in the news and quality investing. My guests are Barron's Deputy Editor, Ben Levison, and Tom Hancock, Head of the Focused Equity Team at GMO and a Portfolio Manager for GMO Quality Strategies, including the GMO U.S. Equity ETF,

Checker QLTY. We're a little bit of a buzz today online. I apologize for that. We're trying to work it out. I want to talk to you about quality investing. First, I'd like to welcome you and Ben to the call. So welcome and let's get started. Thanks, Lauren. Yeah, thanks, Lauren. Great to be here.

You bet. So, Tom, I want to start with some basics. I've heard a lot of people talk about investing in quality over the years, but you've codified the concept in your funds.

What does quality investing mean at GMO and what are the key characteristics of quality? Yeah, these days quality is such a cliche, it almost isn't worth saying, but that hasn't always been true. And GMO has been pursuing the quality style, which we see as distinct from growth or value for many decades now.

For us, quality is about companies that can have sustainable above average profitability. So you need to have moats around your business. You need to have durability. You need to be able to withstand unforeseen events, et cetera. It's that ability to have profitability over time that we think

means a company should trade a premium multiple. And if you think about GMO's history, we're kind of known as a value firm. We're not really, we don't want to just pay low price multiples. We really want to pay up for high quality stocks when they can deliver profitable growth.

So we had a listener, Harry, who asks, what metric is most important to you? Is it return on equity, free cash flow, debt to equity, something else? So from a quality point of view, I think return on equity would be the one thing I'd boil it down to if you had to pick just one. I think that's certainly true philosophically. When you look at the actual accounting numbers, you have to be a little bit careful about

you know, to correct for various things. But that's what we're trying to get at. We look in the past, of course, what you care about is the future in investing. But one nice thing about profitability metrics like that is they do tend to be pretty stable. If you buy high return on equity companies, you tend to get companies that four or five years from now will still have high return on equity. So now that we've established how you define a quality stock, how do you find and identify these stocks? Do you start by screening for certain characteristics?

Yeah, we start our process with screening return on equity, which we just mentioned is one of a number of profitability metrics we look at. So we look at

trailing profitability. And we look over long periods too. You don't want to be fooled about a company that's just at the peak of a cycle. You want to look back long enough to feel like you've captured the cycle. And so we look at profitability over time. We also look at the stability of that profitability. So average year to year changes. And then the third component, which was mentioned too, is balance sheet, debt to equity, net debt to EBITDA, metrics like that. So that's where we start with screening. We do fundamental work after that.

but we find that screening to be very effective. - I suppose we should also ask about performance, given your focus on quality, how has it performed this year and over the past couple of years relative to the S&P and other stocks? - So we're outperforming by a couple percent year to date versus the S&P. If you go back over the last three years,

2022 and 2023 were good years for us on a relative basis. 2022, of course, was the down year with value winning. 2023 was the year where we saw the inflection and growth in AI. So that was

Very good for us to be able to outperform in both. We were very pleased about that the year. I didn't mention until now it was 2024. So we underperformed last year, in particular during the period after the election, which was a run up in, say, the more speculative side of the market. So we had decent absolute return, but we trailed the S&P. And we have a good record across that period cumulatively.

- And Tom, just a question. A lot of these quality stocks are recognized as quality stocks and carry high valuations because of that. How do you go ahead and try to balance the valuation versus the quality?

Yeah. So we've talked about the first step of our process, which is screening on quality. The second step is doing fundamental work to validate the quality. And the third step is valuation. So we have a price target. We have a model for how much we think each company can reasonably grow. Profitable growth is great, but usually or always every company has a limit on how much it can grow.

So that will bound the multiple that we're willing to pay for a company. There are certainly companies that we see as high quality that we don't hold in the portfolio purely on a valuation basis. We won't buy anything that's not high quality, but quality at a reasonable price is kind of the...

Our kind of philosophy, as you could say, I mentioned we outperformed in 2022. That was maybe a key proof point to where a moderate approach to valuation is not that we didn't hold some of the tech stocks, but the portfolio is by no means just a quality growth strategy. And if you if the stock gets too expensive, do you do you sell it or are you willing to hold a stock that you bought at a much cheaper price if it gets expensive?

We're willing to hold it to a point, but if it becomes truly expensive, we'll liquidate. So we'll hold up to say fair value and then liquidate once the stock surges through that.

So let's talk about your broader market view for a moment. The market has been buffeted by a lot of concerns this year about the AI trade, tariffs, inflation and more. Yet after the sell off in March and April, the S&P is almost 100 points from its all time high again. So what do you see as driving stocks higher and where do you think we go from here?

Yeah, the market has been surprisingly resilient, no doubt, given all the stuff that's been thrown at it this year. I think

almost alarmingly resilient. If you look at the overall market, I have to feel that the picture is a little bit more troubled than it was at the beginning of the year. We talked to companies, uncertainty is the most popular word of the year. So we are pretty cautious. That doesn't mean there aren't individual stock opportunities, of course, but we think markets are priced for a level that's going to be difficult for them to sustain.

Companies talk about uncertainty, but investors seem pretty certain that things are getting better. How do you explain that mismatch? Yeah, I think investors have really come around to the idea that the tariffs are really a bargaining chip, not an actual thing that's actually going to happen. I'd say that's a possibility. I wouldn't want to

be as certain about that as I feel like the markets seem to be. And you see today the markets also just shrugging off the geopolitical risk. That's probably not the thing we're most concerned about, but it is sort of, I think, evidence of a real underlying current of optimism out there. Shrugging off seems to be the operative word or words.

So the other big news for investors this week will be Wednesday's meeting of the Federal Reserve's Policy Committee. And while nobody on Wall Street expects the Fed to lower rates at this meeting, we're going to get an update on Fed officials' forecasts for economic growth, interest rates, and other things. And I am curious where you expect the so-called dot clock to show interest rate expectations. Yeah.

I would kind of expect fairly neutral expectations coming out of the Fed. I think the mistake they made last time was not taking inflation seriously enough and no one likes to make the same mistake twice. And so I think there's going to be a real hesitance to lower rates.

particularly when I think they would probably say some of the same things I did about tariffs behind closed doors. I don't think they're convinced they won't happen. And I don't think they're and they already are there now. And I don't think they are convinced that the effect won't be inflationary. So I think there's going to be more reluctance to soften than at least some observers are hoping.

Okay, you invest internationally as well as in the U.S., and I wonder if you can tell me what is the case for international investing given the resumption of the U.S. rally, and which foreign markets do you see as most attractive? Well, we invest in international stocks, and I emphasize the word stocks rather than markets. I'm not sure there's any particular international market I would focus on.

But where we do see a lot of opportunity in stocks are some of those large cap multinationals that maybe you're benefiting from the same themes as some of the U.S. companies, but have been left a little bit behind. One of our favorite non-U.S. stocks is Taiwan Semiconductor. Of course, Taiwan Semiconductor is very integrated with the AI trade and other semiconductor and tech companies in the U.S.,

The pushback on is always the risk from China. Other than that, it has probably a strong competitive position as any company in the world. And I push back to the pushback is that in the kind of bear case of China, that doesn't just affect Apple. I'm sorry, it doesn't just affect TSMC. It affects Apple and all its customers. So no point in paying a premium multiple for a risk that's going to wipe anyone, everyone out.

So we're going to come back to some of the stocks you like later in the call. But I wanted to talk a little bit about Magnificent 7. You hold some of these stocks, but you told me that you don't hold Nvidia. So it is a quality company for sure. What is the aversion? Is it valuation? Is it something else?

Yeah, that gets back to Ben's question about how we think about valuation and that indeed for us, NVIDIA, we think they have a very strong competitive position. They have good hardware and ecosystem around it and dominant market share. A lot to like there, very high margins, but you are paying a lot for

AI beyond, I think, what you can with confidence say is going to be the economic value. Right now, NVIDIA is earning a lot of money and people point to the fact their multiple is not very high, but their multiple is coming from the investments other companies are making to build out capabilities. And ultimately those capabilities have to prove up.

prove out. So this isn't a short case for NVIDIA by any means, because we use AI in lots of ways, it has a lot of very valuable capabilities, but the multi billions and billions of dollars are being spent. That's not quite justified. And we think there are ways that you can get exposure to the upside in AI without paying quite so much for it. And so we think it's kind of

Not the most, I say risk return, not the best trade off out there today. We had a question from a listener, Kevin. He wants to know, can you walk us through how you distinguish between technology names that qualify as quality versus those that may be more growth driven but lack the durability? Yeah. So.

Technology 10, 20 years ago was not a quality sector. At that point, a lot of tech companies were really making hardware that, while it might be the best thing today, some other competitor would come on, duplicate the product tomorrow or come up with something better or just technology would change.

And that really changed. The rise of tech companies came with software and the Internet. So with software, you don't just have great margins. You also have pretty high switching costs. When someone gets used to a particular piece of software, has their data in it, they're not going to switch easily. Internet.

And particularly some of the social media oriented internets have great network effects where you want to be where the users are, the other users are. So once a platform is established, it's very hard to switch off it.

We're looking for companies where we can see switching costs being very high and for them to have opportunities to grow. We generally like asset light companies, but they don't have to be. Like I mentioned, TSMC physical assets can actually be kind of a barrier to entry to competition. If you think about like a Microsoft, which is the biggest stock weight in our portfolios today,

Microsoft also has very strong customer relations. It's really embedded into the IT department of so many organizations around the world that if Microsoft, if someone else comes up with, say, Zoom and people start using Zoom, then Microsoft will come up with Teams. And because they have such a large footprint already, they're going to be able to switch adoption over to that.

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All right. Let's turn to Ben now and talk about some companies reporting earnings this week. We've got just a handful of those, but I think our discussion will lead us to some interesting places, Ben. And I would love to hear also whether these companies are considered quality or not.

We will ask Tom. So the first company is Lennar, the home builder. It's having a tough year. And my question, company reports today, is how bad could things get? They could still get worse. You know, the problem for Lennar is that it is a home builder and it's not getting easier to sell homes right now.

And Oppenheimer was looking at the possibilities and was basically saying that people were expecting a busier spring selling season. That didn't materialize to get their homes sold. All these home builders, sellers of new homes are having to offer discounts

And they're starting to build fewer homes. But Lennar also has this relationship with Milrose Properties, which is kind of a land bank, and that requires it to build homes. So there's just a lot here that could go just not right for it. Oppenheimer actually doesn't think they'll hit.

They'll beat their numbers. They're expected to report a profit of $1.96. That would be down from $3.25 last year for the same quarter. I think the biggest thing it has going for it is that it is cheap. The stock is down at about 10 times earnings. It's been as high as 12 over the past 12 months. But it's really just having a tough time being a home builder right now.

How does the PE ratio stack up against other home builders? That is a good question. I can tell you that. Let's compare it to, let's say, D.R. Horton. You know, they're all around the same, it looks like. D.R. Horton's around 10 as well. Let's see, Toll Brothers, which does, I think, a lot of luxury, if I remember correctly, is actually cheaper. It's down at 7.6 times. So, you know, people don't like home builders very much right now.

And it shows you that in an expensive market, there are some real very cheap stocks. There are. All right. Let's talk about... Tom, I'm guessing Lennar, not quality? Not quality. We do not hold any home builders. I'm right. I'm one for one so far. Okay. This is good. If a stock is trading at seven times earnings, there's probably something there. So there's not likely to show up in our portfolio. Right.

I had a feeling Tom would say that. Now let's shift gears and talk about cruise stocks. And if you'll pardon the pun, they are cruising for recovery after their experience during the COVID pandemic.

We're going to get an update Thursday from Carnival. It's slated to report quarterly results. And so far, so good. And the stock is up about 46% over the past 12 months. Where do you think Carnival will cruise from here? Well, it's, you know, it got hit on Friday. Actually, last week, it was Thursday and Friday, the stock got hit over fears about recession.

with the war between Iran and Israel because oil prices spike, that raises fuel costs for the company, maybe gets people not want to travel. So it got hit pretty hard on Friday, up 4.5%. So there's a lot of volatility right now

These companies are doing very well. I mean, cruise lines in general have just been able to find sort of the sweet spot in travel at this point. It's simple. People are willing to do it. You know, they fly out, they get on the boat and it's easy and it's even a little bit cheaper. So it becomes a fairly affordable way to go travel.

And so Carnival is expected to see earnings rise to 24 cents from 11 cents during the same quarter last year. Sales were actually a little bit lower, but that just indicates that the margins are doing well. We're seeing the demand remain strong and people seem to spend money once they're on the ships, according to Stifel.

And so it looks like, you know, this because of the recent weakness, you know, the stock had pulled back really since President Trump's inauguration back in February. It bounced back, had this little drop, but it's still sitting here around the 200 day moving average. I think that's a pretty decent place for it to find support. So I wouldn't be surprised if it can maybe beat and keep going higher. And if hostilities end, then that would be a...

Better situation, certainly. That is right. So quality or not quality, Tom? I'm afraid not quality for us. Fair amount of leverage here, fair amount of competition. This is not the kind of company that can withstand very bad events very well. So it doesn't have the resilience we'd be looking for. It makes a lot of sense.

although many people think they deliver a quality cruise. Interesting distinction, a quality company does not necessarily mean the highest quality products or vice versa. Okay, understood.

Let's talk about the parent of Olive Garden. That's Darden. The company reports on Friday. And this has been an appetizing stock over the past 12 months. Like Carnival, it's up 46%. So Ben, what has driven this outstanding performance and where does it go from here?

It's kind of been a surprise comeback in the Olive Garden. The folks over at Jefferies were actually taken a bit by surprise. They upgraded the stock recently to neutral from sell. Olive Garden had tried to do--

Paul Cutler: Calls yeah. Paul Cutler: Well, then they talked about why they didn't go to buy on it and partially because they were so late in getting off the cell. Paul Cutler: But they said they know guarded that basically all of garden has had to get itself more into like the value camp and they.

were very worried that they wouldn't be able to do it, to be able to give these affordable prices, competitive prices, and still be able to maintain their margins. And surprisingly, they've been able to do it. Darden has seen that by using, they focused on delivery, they've changed up when they offer their special deals, they're trying to get better at that kind of thing. And that's actually helped them. Sales have been stable.

And it looks like some of this can continue, that the growth at the company really does seem to have picked up and the profit margins are better. I think the biggest reason

reason for worry is the same reason that they didn't upgrade it to buy is that the stock has had a big run. And we've seen this with some others. You know, you've had a stock like Brinker, which benefited from the Chili's challenge, I think is what it was, where you see it have a big run.

And then it pulls back a bit and goes sideways. I think what you'd have to worry here is that the stock, because the big run, it's going to be hard for these numbers to really be able to excite people and that you might get a pullback just because the expectations are high. So I'd be a little nervous about that heading into it, but it's quite a turnaround for Olive Garden. Absolutely. All right. Shall we ask Tom again? Let's ask.

I hate to be Mr. Negative, but it doesn't make the cut for us. It's a very competitive industry and you point to it can have some momentum over the shorter term. But when we think about quality, we're thinking about would we be comfortable locking this

putting it under our mattress for five years. I think there's a little too much competition here and changing consumer tastes for us to have that level of confidence. Do any restaurants reach a level of quality for you? So we don't hold any in the portfolio today. We have held McDonald's in the past. We've

Some of the Domino's pizza is one that I think is very well run. But it's a little bit tough for us with restaurants. That makes sense. Absolutely. All right. Wait till you hear the next one. The grocery industry.

Ben, tell us about Kroger. The company reports on Friday. How's it faring given competition from the Costco's and Walmart's of the world and the impact of tariffs? Yeah, actually, it's been doing pretty well, partially because of the tariff issue. It's not really impacted by it.

So it's made as kind of a safe spot to be in when everyone's worried about that. It has had a pullback recently. It's gone nowhere over the past three months. So it had a bit of a run, then it pulled back and it's right where it started as it heads into these earnings. Citigroup, I think they're feeling pretty good about it. They expect earnings to come in at $1.47, which would be above the fact set consensus of $1.45 and up from $1.43. Sales are about...

the same total, but same store sales are they actually see rising 2.5%. That's sales of stores that have been in existence for 13 months or more. And so they also think that there's going to be guidance will be reaffirmed, but not raised just because of all the uncertainty out there. And the main thing that city is looking for is how market share is holding up.

against places like Walmart and dollar stores. They had mentioned in the past that they've had to shift a little more towards value. What is that going to do to the margins? But so far, they actually seem to be doing pretty well. And I think there's just with so much money going to grocery still and being able to focus on the value side of things that they might actually be able to pull this off. Mm hmm.

All right, Tom, you want to render a verdict here? Well, we don't hold the stock. It's the stock we might hold. I think we've seen more attractive options elsewhere. And I say that, of course, not a very high multiple stock, but it's also not a very high growth stock. And it's hard to get profitable growth because there is competition. I think it has the benefit of its current business is very defensible. But to be able to grow much beyond that is a challenge.

All right. So you've mentioned technology as one of the sectors in your funds. What are some of the other sectors and what are some of the stocks in those sectors that you would define as quality?

So, yeah, tech's a big sector for us. Healthcare is also a big sector for us. And then consumer, which is largely consumer staples type names, that's maybe the third area where we typically have a fair amount of concentration. Just by four examples, in the healthcare sector,

We don't so much invest in biotech. We're not the science experts. But I think large cap pharma is a very underappreciated sector. And people kind of have the, except maybe the curse of the crystal ball that they see any individual patent is going to expire at some point. And they sort of lose that.

the plot that these companies can renew themselves. They've actually been very consistent growers over time. So that's, I think, a little bit of an underappreciated quality sector. We also like some of the med devices. Intuitive Surgical would be one of the bigger growth stories in the portfolio with a really long horizon, certainly one that's not so directly an AI play. And we do like some of those beleaguered managed care companies, the health insurance companies

When you think about consumer, we're often talking about the Nestles and Cokes of the world. And then there'll be some smaller names too that we like in that area.

Ari, can you give us the names of some pharma stocks that you hold? Well, we hold Johnson & Johnson. We hold Merck. We also hold, and these are kind of in a different category, but we hold both actually of the diabetes stocks, the GLP-1 stocks, which are the Eli Lilly, which we've held for some time. And we actually recently initiated a position, Novo Nordisk, they're Danish stocks.

competitor. Then the interesting thing there, I think, is that these two stocks, if you take a longer horizon, it's really a duopoly between those two and diabetes, but there's leadership that will go back and forth. And right now, Lilly is in the driver's seat, but the price spread, the valuation spread between the two has gotten wide enough that we feel like it made sense to diversify our Lilly position. I think you're also a holder of Constellation Brands. Am I right about that? You are, yes.

And I know I've read that the company has had some trouble because of immigration issues, that it sells a lot of beer to Latino immigrants, and that's become an issue for them. Can you explain a little more what's going on there? Yeah.

Yeah, Constellation Brands has been hit with a lot of storms this year. So that's, for people who aren't as familiar, their main business is importing Mexican beer into the U.S. So Corona, Modelo, and Pacifico are Constellation's main brands. And that's

General have been a great business. Beer as a category isn't growing that much, but imported beers and imported Mexican beers in there specifically have been doing very well. Modelo became the number one beer in the U.S. after Bud Light's challenges. However, they do, as you say, over index to Hispanic beers.

consumers in the US. That is a growing population in terms of US market share in absolute sense. That's still true, but there's a lot of fear out there, not just amongst people who feel like they might be deported, but generally people who

hang out with people who might be deported. There's been a lot less socializing in that group. I also wouldn't, if we're talking about this year's results and what they reported in the last quarter, weather is a very important factor. That's the California fires earlier in the year or the rough spring that a lot of the regions have been having. I would not underemphasize that. And I bring up that point. We think a lot of these effects are cyclical. It's been

Very negative year for the stock, but we see it as a pretty good bounce back opportunity over time. I think that the immigration fears will at some point die down. You know, all these issues have kind of a lifespan. I don't think this is a forever problem. So I would say this is probably a pretty good entry point if you have a longer horizon. Let's hope the weather improves around here in the northeast.

All right, we have tons of questions, so I want to get to some of them now. Bruce asks, what is the role of ESG, that's environmental, social and governance overlays, in identifying quality companies? Well,

When we talk about companies that are sustainable for the long run and have long-term profitability, that kind of has an ESG connotation to it. We use sustainability in a financial sense, but certainly companies that are doing something very unsustainable in a social sense are probably going to get into trouble sooner or later. Those chickens will come home to roost would be our view.

I don't think that ESG is this sort of separate thing, though. I think ESG is just a conglomeration of fundamental considerations, some of which are more material than others. And to separate it out as sort of a separate discipline from fundamental investing doesn't make sense for us. And I would say for us, our main objective is a risk-adjusted return over the long run, not trying to achieve any other objective.

Okay. That was an interesting question. We have another one coming from Daniel who wants to know, how do you value the company's founder or CEO or leadership in your quality assistance? So,

When we talk with management and take a view on them, a lot of it boils down to do we think they're doing the right thing for an investment horizon that matches ours, which is many years. What we don't like to see is companies doing financial engineering or short-term decisions or

They frankly doing things that they think is what the market wants them to do around what they think is right for the company. So that's what we avoid. There's a famous Warren Buffett quote about I like to invest in companies that ham sandwich can manage sooner or later one way.

We don't want to invest in those in the ham sandwich companies. But I think you can get in trouble getting seduced by management that's a little too clever for their own good. So we like sort of slow and steady wins the race type management. We do tend to like, you know, on average founder led companies or companies where these

management team has, let's say, the confidence to make the right long-term decisions. Sure, they won't get everything right, but we like the alignment of incentives that founder-led companies tend to have. All right, we'll stick with Daniel for a moment. He wants to know, for companies or startups that are not yet profitable, how do you assess quality?

Yeah. So generally, we don't have that much exposure to startups. We you want to see companies prove it before we will believe it. And of course, that does mean you'll leave something on the table. But our experience is with the really great companies, it's OK to be a little bit late. You know, they still have a lot of runway. You don't have to buy Alphabet the moment you're

it comes into the market, it has a very long run. So there will be some cases where, for example, when Visa was spun out of the banks,

kind of knew what Visa was, understood the business, the business had been around for a while. That's where we might buy a quote, new company, unquote, but something that's truly a startup isn't going to be our thing. We think of these kind of as lottery ticket ideas, like a few lottery tickets pay off, but if you buy a lot of them, it's probably a losing proposition. You got to wait for the payoff in some ways.

So speaking of new companies, Ben, I wanted to ask you about the IPO market. Alex has asked for your forecast for 25 and 20. That's the initial public offering market has hooked up lately with new issues. What do you see ahead?

I mean, it seems like companies do see some of a kind of a window here for them to go public. And so they're taking advantage of it. I don't know how big a boom is going to be and how long this window lasts, but we're going to see more of them. There's more interest in them. We're seeing some interesting companies get mentioned.

One that Al Root has talked about is Andoril. They haven't set a date, but there is some speculation that they might look into one. So it is there. With M&A, the year started off pretty poorly just because there was so much uncertainty. And it's picked up a bit. We have started to see deals, a lot of health care deals. There was Safe Therapeutics was, I think, bought today.

And that's going to give things a pickup. We'll learn more when we hear the bank's report. That's going to be a few weeks from now, still in July, when they start to come out with their earnings to see if that can continue to pick up. But it's still it's better than it was, but it's still not super hot yet. But better than it was. Yeah, it was. I mean, it was really dead to start the year.

All right. Another question for Tom. We asked Tom whether you look at earnings consistency year to year as an important hallmark of quality. Yeah. So from a screening point of view, we definitely look at it historically because we found that if you're a high profitable company kind of year in, year out, that's a lot more indicative of what the future will bring than if it's very volatile. That said,

We do think cyclical companies can be high quality companies. If you're a cyclical company that is going to be very profitable across the cycle, has the strength of balance sheet that you can survive the downturns. In fact, often companies can strengthen themselves in the downturns if their competitors are weaker and they can get assets on the cheap. And also they tend to have more volatile stock prices, so you get better trading opportunities.

So we will buy some companies with more volatile earnings, but that's not the core of the portfolio and it's not what we screen for. Okay. We had a question from Smith who wants to know what is the average high-low PE across the portfolio or what is the average price earnings multiple across the portfolio?

The average P, it's not that far from the S&Ps. It's about 20, 21. And that's, I made a remark earlier about seven times earnings probably not being our thing. It's around 21, but with a relatively tight range. You'd see the majority of the portfolio between 15 and 25, which is sort of the sweet spot of where great businesses, you're not going to get too much of a discount.

but you don't have to underwrite too much in the way of growth. Yes, we will go up to 30 for some of the great tech companies, or of course, there's some situations where the earnings are a little bit cyclically depressed, you can go get by them. But I think quality on its own gives you a little bit of a premium portfolio, if you were to just apply it as a factor, but our approach, which takes into account valuation, gets us more toward the market.

Got it. All right. Now let's talk about a couple of companies that readers are interested in, kind of like what we did with Ben and the companies he mentioned. James wants to know, do you view Costco as a quality stock?

Yeah, Costco is absolutely a quality stock. We've held that stock for a very long time and unfortunately exited it on valuations. I say unfortunately because we exited it when it was, I think, in the 30s on valuation to my previous point, and it's only gone up from there. It's hard for us to justify at this price because it's another one where the growth is not

available is not particularly high, but it's a well-run company with a very strong brand, very strong business model, certainly a quality business. And by the way, that does bring a distinction when people talk about profitability. Sometimes people talk about profit margins as being quality. They, of course, have relatively low margins relative to their sales, but what they do have is very high return on equity, which is what Matters does. Well, in the grocery business, margins are low.

So next stock, Amazon. Stafford wants to know what your thoughts are on Amazon. Yeah, we hold Amazon. We haven't held it as long as I wish we have given its great success, but we've held it for about five years, I think.

What really got us positive on Amazon was the evolution of Amazon Web Services and their cloud offering, and also how they've been able to lever their so-called one piece. So when you first party, when you buy something direct from Amazon and they're the seller into a very profitable third party business where they become a platform company where you're buying from other sellers and they're the network effects come into play.

It's a great company. It's interesting that's one where to the earlier question about earnings volatility, they actually have fairly high earnings volatility because they're not afraid to invest. They sort of do the opposite almost of managing their earnings. So that would be a case where you'd look past that and say, yeah, great business. Luis wants to know whether any liquidity metrics are part of your equation for quality.

Not per se. There's certainly a correlation between quality and size. And if you look at our portfolios, you'll see they tend to skew fairly mega cap. And of course, there are practical issues around investability for really small companies, but we wouldn't see it as part of the definition of quality.

All righty. And we will close with a question from Matt, who says, you mentioned investing in pharma and managed care companies, and indeed you did. With the president pushing for lower drug prices and lower prices generally across healthcare, what is your thinking on purchasing and holding these companies?

So he's pushing more or less for lower prices almost and more for equal prices around the world. And of course, if the prices equilibrate by them going up elsewhere, that's not bad.

We can we believe that from the drug company point of view, you will be they continue to pay for innovation. I think we are getting as a society, we're getting value out of COVID vaccines, out of GLP-1, out of the extension of COVID.

quality life for cancer patients that we have over versus decades ago and i think we're in the fortune fortunate situation of being a rich society that can afford to pay for that and i think we will want to so i don't think ultimately there's going to be a cut cut off in either

Pharma prices or in the research biotech research that supports that I would say on the other hand that you can't let profits run away So the pharmacy benefit function that exists within managed care companies. That's the so-called middleman that gets a lot of negative Publicity, I think that negative publicity is overdone and those companies serve a value for valuable function, too. I

All right. I do have one more question I wanted to ask you about. It came in from a listener. Can you talk a little bit about Alphabet and Google? Yeah. So we hold Alphabet. There are maybe two things, and it's a stock that's 19 times earnings for very solid growth. So that's a good starting point. There are two things to worry about. There's the government cases that may potentially could lead to a breakup of the company.

And there's the question of whether AI is going to disrupt the Google search cash cow. I'd say quickly on the government side, we think that the worst case breakup between the ad tech and the search, that's actually not that bad for someone who holds both companies apart, is not that much worse than both companies together.

I think there is some testimony from an Apple executive in trial saying, oh, Google search their AI opportunities. Maybe it's not so great. Remember where he was saying that he was saying that in trial, he really wants to keep the Google relationship. And I think that speaks to the strength of it. And Google's own AI capabilities are very powerful. They're monetizing.

at the same rate as traditional search. And Google does have the big data advantage, which a lot of it isn't just the algorithms, it's the data. So I think they're in a strong position. We're certainly going to watch it because Google search isn't quite as undisruptable as it felt two or three years ago, but they're still in a very strong position. And by the way, we should not forget that Alphabet is not just Google. So YouTube is a very profitable business for them too. Right.

That's for sure. Do you give any valuation to Waymo? We do. We actually changed a few years ago. We didn't give it any valuation at all, almost negative because the cash drained. But we do think we've been in the cars in San Francisco. They work. We think there's I wouldn't want to make certainly as a quality investor, wouldn't want to make that be the basis of my case. But I think there is a valuable asset there.

Interesting. We are going to have to call it there today, but it's been a fascinating conversation, Tom. Thank you so much.

Thank you. I've enjoyed it. Yeah, it's been great. Thank you, Ben. And thank you to our listeners for your very short questions. Next week on Barron's Live, Ben and I will welcome Keith Lerner, who's Co-Chief Investment Officer and Chief Market Strategist at Truist Advisory Services. We'll talk about the market. We'll talk about stocks and all the things you tune in to hear about. We're looking forward to that. Thanks, everyone, for joining us today. And we hope you'll join us again next week. Have a good week.

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