Owning high-quality stocks seems like a no-brainer. (Have you ever heard an active portfolio manager tout a portfolio of low-quality companies?) But it turns out that identifying the good names isn't quite so simple.
Like beauty, quality can be in the eye of the beholder, to an extent. The varying definitions of this stock grouping can make it hard to determine whether investors should put their money there.
"Quality is not one factor. It can mean profitability, durable cash flow, high returns on capital, balance sheet strength, or earnings visibility, depending on the index or manager," Bank of America's Research Investment Committee headed by Jared Woodard. "Definitions matter."
One of BofA's go-to metric? Free cash flow.
"Since the start of 2025, a quality approach using both trailing and forward free cash flow has outperformed the S&P 500 and a trailing-only quality index," Woodard and team write.
The firm is still interested in finding quality, however you slice it, but notes that looking at cash flow might not offer up the usual suspects. For instance, hyperscalers have spent some $234 billion this year during the artificial-intelligence spending boom. Their steep AI investments have eroded their cash flow, and forward free cash flow for the group will likely turn negative for the first time in nearly two decades. No wonder the Magnificent Seven stocks have lagged behind the S&P 500 this year.
"Against that backdrop, many overlooked areas offer materially better value," notes Woodward.
With U.S. household cash balances still 33% above pre-Covid trend, the committee sees room for "a continued broadening beyond megacap tech," the report notes.
Individual analysts at BofA think power producer " Vistra Corp. is compelling because it combines tight power markets, rising datacenter demand, and substantial free cash flow," he notes.
Likewise, Moody's Corp. $(MCO)$ should benefit from a ratings recovery (the more debt issuance and refinancing, the more work for the company), its high-quality analytics business, as well as AI-driven upside.
BofA also likes Intuit, whose stock has slid 56% this year. The selloff -- on fears that AI will take over tax preparation -- is overdone for a company "with Intuit's margins, cash flow, and embedded customer relationships," the committee says.
Yet Trivariate Research President Adam Parker warns that regardless of industry, buying high quality companies alone hasn't been a winning formula in recent years. That is because the AI-led tech rally has favored more speculative, faster-growing names.
He notes that among investing strategies, "momentum, which has been incredibly effective as a factor over the last few years, has not worked among high-quality stocks."
Parker flags Microsoft, Meta Platforms, Netflix, T-Mobile, and Abbott Laboratories as high-quality stocks that have had "poor 12-month price momentum."
Clearly then, it isn't big tech that is sinking momentum for high-quality stocks. Nor do quality names seem to get rewarded for showing improvement. Using his own quality-ranking system, Parker found that if a high-quality company's fundamentals are failing, stocks will perform poorly. That makes sense, but he also found that high-quality stocks with the most improving scores also lagged behind the market. (Digging a little deeper showed that value stocks could get an improvement bump, but that didn't show up for growth stocks.)
Parker has previously noted that the best performing high-quality companies combine growth, heavy research and development investment, low debt, and strong price momentum. Still, he questions if investors should be using this metric at all.
"We don't think investors should focus on quality -- unless they are trafficking in junk stocks or value stocks, where buying companies where the quality will improve has some merit," Parker concludes.
So much for the old phrase, "You get what you pay for."
Write to Teresa Rivas at teresa.rivas@barrons.com
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(END) Dow Jones Newswires
July 13, 2026 15:25 ET (19:25 GMT)
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