High-quality stocks set for high returns

published 5 June 2019

A professional investor tells us where he'd put his money. This week: Hugo Ure of the Troy Income & Growth Trust highlights three favourites.

The Troy Income & Growth Trust aims to provide shareholders with an attractive yield and the prospect of both income and capital growth. Historically, the key to market-beating returns with lower-than- average volatility has been investing in high-quality equities. We interpret quality as a preference for capital-light companies that can sustainably generate high returns on capital. As part of our endeavour to shield investors from excessive equity-market volatility, we employ a hard discount control policy, ensuring that not only do the trust's shares continually trade within a few percentage points of the underlying net asset value, but also that investors can enjoy significantly improved liquidity when buying and selling the trust's shares.

We often find franchise companies provide interesting hunting grounds and the trust currently holds shares in Domino's Pizza (LSE: DOM). As with all franchise companies, the challenge for management is to balance the value that accrues for the franchise owner with the profitability of the franchisees. A concentrated franchisee base, labour-cost pressures and ambitious UK store-opening targets have conspired to unsettle this balance recently. This dislocation offers investors an opportunity to buy shares in this high-return and capital-light business at the most attractive valuations since the depths of the global financial crisis.

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Achieving diversification without compromising on quality has also been hugely important to our strong returns. Stocks as varied as Unilever and consumer-credit group Experian (LSE: EXPN)have been leading contributors to long-term performance. Experian's modest dividend yield (1.5%) and above-average price/earnings ratio of 27 make it a more unusual holding in the context of the portfolio. At its core, Experian remains a credit bureau and a crucial provider of the data that underpins society's need for fairly priced credit. What is less visible is its evolution from a simple data supplier into a developer of sophisticated software and analytics tools.

It is rare for us to own highly cyclical companies. Nonetheless, there are a handful of exceptional industrial and chemical companies that enjoy both high returns on invested capital and are insulated from downturns by robust balance sheets and a long-term approach to strategic planning. Victrex (LSE: VCT) is one such example. The company manufactures PEEK, a high-performance plastic used in everything from aeroplane parts to dental implants. It is testament to the company's stewardship of this technology that despite the expiry of the molecules patent many years ago, it still boasts 70% of global production and is actively growing its markets.