"We define a quality security as one that has characteristics that, all-else-equal, an investor should be willing to pay a higher price for: stocks that are safe, profitable, growing, and well managed. High quality stocks do have higher prices on average, but not by a very large margin. Perhaps because of this puzzlingly modest impact of quality on price, high-quality stocks have high risk-adjusted returns. Indeed, a quality-minus-junk (QMJ) factor that goes long high-quality stocks and shorts low-quality stocks earns significant risk-adjusted returns in the U.S. and globally across 24 countries. The price of quality – i.e., how much investors pay extra for higher quality stocks – varies over time, reaching a low during the internet bubble."

"Our results present a puzzle for asset pricing. They are consistent with quality stocks being underpriced and junk stocks overpriced or, alternatively, with quality stocks being riskier than junk stocks. However, while one can never rule out a risk explanation for the high return of quality stocks, we are unable to identify this risk; in anything, we find evidence of the opposite. We show that quality stocks are low beta and, rather than exhibiting crash risk, if anything they benefit from “flight to quality,” that is, they have a tendency to perform well during periods of extreme market distress. These findings present a challenge for risk-based explanations where bad states of the world are negatively correlated to extreme return realizations of the market factor. Finally, we show that the price of quality varies over time, generating a time-varying expected return on quality-minus-junk portfolios: a low price of quality predicts a high future return of quality stocks relative to junk stocks."

“Insurance company American International Group, Inc. (NYSE:AIG) was also among our top contributors. The company’s most recent operating results outperformed expectations, as it reported robust earnings with improving underwriting margins in the property and casualty business. AIG’s strategic initiatives also added to the positive sentiment. The company made further progress in separating its Life & Retirement unit by selling additional shares via a secondary offering. Furthermore, AIG announced the sale of its reinsurance business to RenaissanceRe at an attractive valuation, a move that will further reduce volatility in AIG’s continuing operations.”

"We stayed neutral on analog for too long this cycle, since stocks bottomed an unprecedented full year before fundamentals began to deteriorate," Wolfe Research analyst Chris Caso said in a note.

“We added a new position in Microchip Technology, Inc., (NASDAQ:MCHP) to the Fund during the quarter. Microchip is a leading provider of mixed signal microcontrollers and analog semiconductors to a broad range of industrial, data center, automotive, communication and consumer appliance customers. The company enjoys favorable product characteristics that help drive strong profitability, and it benefits from several long-wave demand tailwinds such as electronification, automation, and growth in data communications. While Microchip is not immune from semiconductor cycles, its cash flows have been durable through cycles. The multi-year outlook is solid, and we think the company is poised to further boost per-share value growth through increasing share repurchases at discounted prices.

“Paychex, Inc. (NASDAQ:PAYX) (3.71% weight in the Fund): While employment growth was strong in 2023, the Fed’s efforts to moderate job growth was successful. Paychex business is driven by the number of employees on the payrolls of its small to medium size business customers. With recession worries percolating all year, the stock was flat on a year to date basis in late October just as the economic outlook began to brighten. As recession worries faded the stock rallied to gains of as much as 13% in the fourth quarter. But in the late December earnings report, the company said that core payroll services growth would be a bit weaker than investors expected. Despite this, the company slightly raised full year earnings guidance as demand for their full service solution that incorporates human resources services beyond payroll improved. The stock finished the quarter up 4.1%.”

“The company has a market-leading position in a fragmented industry and should benefit from our optimistic view of single-family housing starts in 2024. Growth in value-added products increases the amount of revenue tied to services and is a positive for gross margin and returns.”

“Over the past 12 months, interest rates have been increasing, which has reduced the economics of this strategy; but a large spread still exists if assets can be purchased at the right price. Increasing interest rates has affected the returns on public LBO firms. Some firms, like Builders FirstSource, Inc. (NYSE:BLDR) (described below), have reacted to higher interest rates by moderating their use of debt in their expansion plans.

Builders FirstSource, a portfolio holding, is an example of a private LBO. Given BLDR’s current valuation of an 11% earnings yield and, more importantly, a five-year forward earnings yield of 15%, buybacks are accretive. The net income annual growth is expected to be between 17-20% over the next four years based upon management’s guidance. This net income growth would imply a 17-20% total return before changes to the current modest valuation of 9x earnings. Below is the history of BLDR’s RoIC and RoIIC…” (Click here to read the full text)

“In the second half of 2023 — as we were selling low-growth, high-multiple stocks and taking advantage of oversold conditions in infrastructure, real estate and utilities — we also found opportunities in overlooked areas of health care. After adding Gilead Sciences, Inc. (NASDAQ:GILD) in the third quarter, we bought AstraZeneca in the fourth quarter. Each of these stocks present distinct investment cases, but both are reasonably valued and have limited patent expiry or pipeline risk. Gilead’s strength comes from its dominant franchise in HIV. It offers lower growth, but it yields nearly 4% and trades at 11x earnings. AstraZeneca possesses a diversified portfolio of pharmaceuticals, which should deliver double-digit earnings growth, yet it trades at just 16x earnings. These stocks were underwritten individually, but collectively we like the idea of increasing our exposure to defensive and growing health care names at below-market multiples.”

“Other meaningful moves during the quarter included additions to cyclical growers we consider early cycle consumer plays: Target Corporation (NYSE:TGT), a position initiated in the third quarter, and Estee Lauder. As earnings start to recover, these stocks and semiconductors tend to be among the first to move. We may be a little early and could see some choppiness in stock prices as job growth and consumer spending cool due to the lagged effects of Fed tightening, but we believe we’re closer to the bottom in terms of economic activity and that both companies, as well as Union Pacific, are well-positioned to benefit as consumer sentiment improves and the economy begins to recover.”

“We are optimistic about equities with the (SPX), (INDU), and (NDX) hitting record highs, but waning market breadth is a notable concern. We saw some signs of rotation yesterday as SMID-caps began rallying out of their three-week pullbacks.”

“Cisco Systems, Inc. (NASDAQ:CSCO) is the leading networking solutions company. Networking equipment becomes more important as businesses modernize their IT infrastructure, and Cisco is well positioned to capture this demand given its broad portfolio and highly effective go-to-market strategy. Cisco is transitioning away from selling mainly transactional hardware and toward selling more software and subscriptions. This shift is expected to accelerate revenue growth, improve operating margins and build recurring revenue. Despite these notable business improvements, Cisco still trades near a trough valuation relative to the S&P 500 Index. More recently, Cisco announced its intention to acquire Splunk, a leader in security and observability, adding to its already strong position in the increasingly important security market. At a low-teens multiple of our estimate of normalized earnings, Cisco is trading comfortably below our estimate of intrinsic value.”

“During the quarter, we sold our positions in Bristol-Myers Squibb Company (NYSE:BMY) and The Walt Disney Company. We added Texas Instruments as a new position. Bristol-Myers has been dealing with the loss of exclusivity for Revlimid, one of its key products. Although the company is launching new drugs in melanoma, heart failure, and psoriasis it will need additional products to offset the lower revenue in Revlimid.”

“PepsiCo, Inc. (NASDAQ:PEP): PepsiCo is a leading global beverage and snack food company with a portfolio of brands, including Lay’s, Doritos, Cheetos, Gatorade, Pepsi-Cola, Mountain Dew, Quaker and SodaStream. The company, through its operations, authorized bottlers, contract manufacturers and other third parties, makes, markets, distributes and sells a wide variety of beverages and snack foods, serving customers and consumers in more than 200 countries and territories.

PEP, through acquisitions, marketing, and product innovation has reinvigorated top line expansion and is now expected to grow revenues in the mid-single digit percent rate for the foreseeable future. We expect this revenue growth to drive margin expansion and free cash flow growth from $5.6 billion in 2022 to $12.3 billion in 2028. Based on this more than doubling of free cash flow and the company’s 2.8% dividend yield, we believe we can achieve double digit rates of return from the stock regardless of the economic environment ahead. We initiated a small position in August.”