The old argument that you get what you pay for isn’t always easy to apply to stocks.
It can be hard to tell the difference between truly great businesses and companies that are just enjoying a good spell. But as I’ll explain today, I think there are some reliable signals we should be watching for.
I’m going to take a look at two companies I think rank among the best quality stocks in the FTSE 100.
Knowledge is power
Relx (LSE: REL) has based its business model on the idea that people will pay generously for reliable access to high-quality information and analysis.
This £39bn firm, which was previously known as Reed Elsevier, is the world’s largest publisher of academic journals. Relx also provides analytics tools for businesses, a legal data service and runs exhibitions.
The group hasn’t cut its dividend for 20 years and consistently generates operating profit margins above 20%. Growth has been strong too — operating profit has risen by 50% over the last five years.
Relx’s latest results suggest that the company’s strong performance may continue. Sales rose by 5% to £7,874m in 2019, while operating profit climbed 7% to £2,101m. Importantly, these profits were backed by strong cash generation. My sums show underlying free cash flow of £1,789m, compared to after-tax profits of £1,509m. That’s an excellent performance.
The ultimate company?
I believe this could be a great business. The only risk I can see is that Relx is facing growing resistance from universities to the level of fees it charges for access to its academic journals. There’s a growing movement towards open access publishing, which makes publicly-funded research free to read.
This could be a problem for Relx, as profits from these journals account for about 40% of the group’s total earnings. However, there are already signs that the company is adapting by bundling data tools and analytics services with journal access.
Relx shares look a little pricey to me, on 21 times 2020 forecast earnings and with a dividend yield of 2.4%. But I think there’s a strong chance this business will adapt and will continue to grow. I’d buy the shares on the next market dip.
Guaranteed quality
Another FTSE firm I rate highly is testing and certification specialist Intertek Group (LSE: ITRK). This company operates 1,000+ laboratories in over 100 countries, providing a complete package of quality assurance services to customers.
It’s a valuable and essential business. Large international companies have complex global supply chains. These rely on common standards and traceability to ensure that the products they produce are consistent and free of defects. Intertek guarantees this.
This specialist firm operates in almost every major industrial sector and has grown significantly in recent years. Revenue has risen by an average of 5% per year since 2013, while profits have climbed at a rate of 7.2%.
Like Relx, Intertek enjoys above-average profit margins. Last year the group reported an operating margin of more than 15% and generated a return on capital employed of nearly 23%.
Demand for Intertek’s services could fall temporarily during an economic slowdown. But over the long term, I think this business can only grow. As with Relx, I think Intertek is a stock to buy on the dips.