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At ������ɫ��Ƶ we regularly highlight our focus on “high quality companies.” And as a result, we are frequently asked “what does high quality mean to you”?

Simply put, high quality companies are those that have delivered strong and steady economic returns and are well positioned to continue to do so into the future. Of course, we acknowledge that there is no absolute standard for “high quality,” and that the concept itself is subjective. More important, while the idea may seem straightforward, successfully identifying such businesses is not.

So how do we go about finding such companies? The first part of our process is to identify “markers” of business quality that can be readily quantified. Examples of such markers include a persistently high and stable return on invested capital (ROIC) relative to peers, a strong financial position, a history of steady revenue growth, and the ability to fund operations through internally generated cash.

But we seek to go well beyond analyzing these quantitative metrics that are historical in nature. We also strive to determine whether a company’s history of success can persist long into the future. This exercise is more qualitative than quantitative and less science than art. Simple questions are frequently the most relevant: Is it easy to understand how the business makes money? What, if any, is its competitive advantage over peers? Is its industry likely to continue growing? What risks does the company face and how might it fare in an economic downturn? This is how we spend most of our time in our investment meetings, vigorously discussing these sorts of questions and challenging each other to support our assessments. By approaching our investment selection process in this manner, we avoid the Wall Street practice of trying to predict the short-term future of a company with the implied precision of an Excel spreadsheet.

So, why do we focus so much attention on identifying such companies? Because we have found that diversified portfolios of high quality companies are better able to sustain good investment returns when markets decline, or when investors become more risk-averse. Moreover, over long periods of time we have observed that such portfolios can deliver returns that are attractive in both absolute and relative terms.