The ASX-listed exchange-traded fund (ETF) Betashares Global Quality Leaders ETF (ASX: QLTY) is one of my favourites for a variety of reasons.
Investing in the global share market is a great thing to do, but that usually means getting indirect exposure to thousands of businesses. I wouldn't say that every one of those companies are as good as the best ones. In theory, those lower-quality holdings may deliver lower investment returns.
So, why not just invest in the best ones? That's essentially what the QLTY ETF is trying to do. The ASX ETF aims to invest in 150 of the highest-quality global companies from across the global stock market.
Let's look at how that portfolio is created. There are four factors that determine whether a business is worthy of being included in the portfolio.
Return on equity
The return on equity (ROE) seems to be one of the most followed financial statistics by analysts.
The ROE tells investors how much profit a business is generating when measured against the amount of shareholder money it retains within the company. Businesses that require lots of shareholder money to make a good profit aren't very appealing. A low ROE suggests investors may earn relatively low returns on future profit retained within the business.
However, businesses with a high ROE are impressive and they will likely be able to earn good returns on additional money invested within the business. This improves the chances of superior future returns for shareholders.
Debt to capital
As shareholders, we want our businesses to utilise the best financial structure to deliver sustainable returns for investors (and the ASX ETF), which may include taking on debt.
But, loading up on too much debt can be risky and come with sizeable interest costs.
If a company has a low level of debt compared to the overall size of the business, it suggests the business is in a healthy financial state and isn't at risk of breaking its debt covenants.
Being in a good financial state also means that the business is capable of making acquisitions, which is particularly useful during economic downturns when they can buy financially distressed competitors.
Cash flow generation ability
Receiving real money is ultimately what shareholders want to see. Companies can use that cash flow to pay dividends, invest in new assets and so on.
Shareholders should want companies to make real profit. Accounting profit can be massaged to make it look better than it really is.
So, we want to see that profit is being converted into real cash flow into the company's bank account.
Earnings stability
If profits aren't going down, then it logically means profits are going up.
Quality businesses should be able to regularly grow their profit, which may help unlock somewhat consistent returns. Or, at least more predictable returns than volatile businesses like ASX mining shares.
If investors have confidence that profits are likely to increase almost every year, it may mean that these high-quality companies experience smaller declines during economic downturns.
While past performance is not a guarantee of future performance, it's no surprise to me that QLTY ETF has delivered an average return per year of 15% since November 2018. I believe it can continue delivering pleasing returns over the long-term.
