Figure 1: The impact of ESG on company fundamentals

Source : Bancel et al (2023) in Klement on Investing

Researchers asked more than 300 portfolio managers, financial analysts and ESG specialists what they think of ESG (environmental, social and governance) criteria and how they use it in practice. When asked how ESG data influences company fundamentals, a majority of investment professionals responded that higher ESG scores have a positive influence on reducing the risk level of companies. When asked how ESG data influences company fundamentals, a majority of investment professionals responded that better ESG ratings positively influence the reduction of company risk, improve long-term company growth, reduce the cost of debt and the cost of equity for these companies. Several studies have scientifically demonstrated that some of these views are true, particularly with regard to risk levels and the cost of debt. Moreover, better ESG ratings change the valuation model of companies that therefore deserve a premium (a higher risk premium) because of this greener and less risky ESG profile.

Figure 2: AI invades earnings calls

Source: Bank of America

A Bank of America study shows that the mention of the term "artificial intelligence" in companies' earnings calls has increased by +85% year-on-year. This social phenomenon is not only a fad but a reality, especially since the appearance of a multitude of tools based on AI such as ChatGPT from OpenAI, Bard from Google, DALL-E or Midjourney to name only the best known. Showing your investors that you are taking the turn of artificial intelligence is essential for companies.

Graph 3: The infinite ceiling of the American debt

Source: Visual Capitalist

It's a recurring dilemma that comes up roughly every two years on the table: will we raise the U.S. debt ceiling? In January, the $31.4 trillion limit on the amount of debt the U.S. government can hold was reached. Discussions are underway to avoid a default. The ceiling would normally be raised to avoid a default, which would result in a suspension of government salaries and some pensions, as well as a delay in interest payments on Treasury bills.

The chart above shows the increase in the US debt since 1970. This has accelerated since the subprime crisis of 2008-2009 and after the health crisis of 2020. Nevertheless, we are reaching dizzying levels since in 2023, the US government is indebted to 133% of its GDP, a historically high level compared to its average of 65% of its GDP since 1940.

Chart 4: Quality at a reasonable price beats the market

Sources: FactSet, Bernstein, CRSP and Schroders

This chart represents the performance of two investment strategies applied to the UK market: investing in quality companies (dark blue curve) and investing in quality companies that are reasonably priced (green curve). These two strategies are compared with a benchmark for the UK market: the MSCI UK. Over a long time horizon (here since 1990), the QARP (Quality at a reasonable price) style achieves an annualized performance of 15.7%, almost double the benchmark (MSCI UK) at 8.3% per year. At the end of 32 years (1990-2021), these few percent more each year leads to a cumulative performance 5 times higher in fine. The QARP strategy aims to build a diversified portfolio of stocks with solid fundamentals (high return on equity, margins above the industry, stability of earnings over time, etc.).The QARP strategy aims to build a diversified portfolio of stocks with solid fundamentals (high return on equity, margins above the industry, stable results over time, controlled debt, etc.) and to pay the lowest possible price for them (in terms of financial ratios such as P/B, P/S, P/CF and dividend yield).

Based on this research, I have created a style list of investment on quality stocks at a reasonable price which is based on a very similar strategy. Companies of sufficient size and liquidity that meet qualitative criteria of financial strength, business model stability and return on capital are selected. The valuation filter then ranks the companies according to their attractiveness by comparing their capitalization and/or enterprise value to their revenues (EV/Sales), net income (P/E) and free cash flow (P/FCF) in order to retain only the least expensive. This strategy has been backtested and beats the market over the long term.

Figure 5: A qualitative company in a duopoly situation

Source: Cadence Design Systems

Cadence Design Systems is a specialist in the development of integrated circuit design software and electronic design automation hardware. Cadence is in a duopoly situation with its direct competitor Synopsys in the field of semiconductor software. The company has consistently increased its revenue, margins and return on investment to shareholders over the past 10 years. Cadence serves a diverse customer base across all industries and around the world. It is at the front end of the semiconductor value chain and is less sensitive to economic cycles. Cadence has high margins (net margin of 23.8% in 2022), an impressive return on equity (ROE of 42.8% in 2022) and a strong balance sheet (more cash than debt). The share price has moved in a linear fashion (on a logarithmic scale) since the bottom of the subprime crisis in 2009 and has climbed nearly +9000%.