High Quality Stocks, ETFs To Beat The Market

With a rate hike in the cards and a slew of mixed economic reports, the U.S. stock market might see a tough ride in the months ahead. The Fed is on track to raise the interest rates for the first time since 2006, provided the world's largest economy continues to improve.

While an accelerating job market, a rebounding housing market, and a raft of upbeat economic data point to a substantial improvement in the economy after the first-quarter slump, disappointing consumer spending data, weak consumer sentiment in May, and a downward revision to first-quarter GDP growth raises questions on the health of the economy.

Added to the stock market worries is the resumption of the dollar rally and oil price slide, an aging bull market, Greek default concerns, and stretched valuations. Yet, a rally in the stocks can come from increased merger and acquisition activities on the one hand, and better-than-expected corporate earnings on the other.

All these are signaling huge volatility and uncertainty for the stock market. Given this, quality investing seems prudent.

Why Quality Investing?

Quality stocks are generally rich in value characteristics and focus on high quality scores based on three fundamentals factors – high return on equity, stable or rising year-over-year earnings growth and low leverage. This approach seeks safety and protection against volatility in turbulent times.

Academic research shows that high quality companies consistently deliver superior risk-adjusted returns than the broader market over the long term. More importantly, these stocks generally outperform in a crumbling market.

Fortunately, there are some solid picks in both the stock and ETF spaces targeting this niche strategy. We have detailed them below. Any of these could enjoy smooth trading and widely outperform the U.S. market in the coming months.

Stocks to Consider

To find out the best stocks in this space, we have used our Zacks stock screener. The parameters include Zacks Rank #1 (Strong Buy) or 2 (Buy), ROE of at least 10%, debt-to-equity ratio of less than 1, historically positive 5-year EPS growth, positive current-year EPS growth, positive current-year earnings estimate revisions over the past 60 days, and dividend yield of greater than 1%.

Manulife Financial Corp (TO:MFC)

Based in Toronto, Canada, Manulife Financial is a leading financial services company with principal operations in Asia, Canada and the United States. It provides financial protection products and investment management services to individual, corporate and business customers. The company has a solid track record of above-average earnings growth of 96% over the past 5 years and this trend is likely to continue with the expected 26% earnings growth for this fiscal year. The current Zacks Consensus Estimate for 2015 has risen by 3 cents to $1.47 per share over the past 60 days.

Manulife’s debt-to-equity ratio of 0.11 is one of the lowest in the industry and return on equity of 9.1% is above the industry average of 7.7%. The company also has a solid 3.04% in annual dividend yield. The stock has a Zacks Rank #2 and a solid Zacks Industry Rank in the top 40%.

Marriot Vacations Worldwide (NYSE:VAC)

Based in Orlando, FL, Marriott Vacations is a recognized industry leader in developing, marketing, selling, and managing vacation ownership and related products. Its brands include Marriott Vacation Club, The Ritz-Carlton Destination Club and Grand Residences by Marriott. The company has seen earnings growth of 46.9% over the past five years and expects 18.3% year-over-year earnings growth this fiscal year. Further, over the past 60 days, earnings estimate revisions of 5.15% has been solid to $3.47 for the current fiscal year.

From a balance sheet perspective, Marriott Vacations has lower debt with debt-to-equity ratio of 0.59% while return on equity (ROE) is high at 9.86%, much higher than the industry average of 16.4%. Additionally, it yields 1.12% in annual dividends. The stock has a Zacks Rank #1 and boasts an excellent Zacks Industry Rank in the top 20%.

ETFs to Consider

While several quality ETFs are currently available in the market with most of them focusing on the dividend aspect, we have highlighted two U.S. funds that hinge on broad quality aspects.

MSCI USA Quality Factor ETF (NYSE:QUAL)

This fund provides exposure to the stocks exhibiting positive fundamentals (high return on equity, stable year-over-year earnings growth, and low financial leverage) by tracking the MSCI USA Quality Index. In total, the fund holds 125 securities in its basket, which are pretty spread across a number of securities with none holding more than 5.06% of assets. Apple (NASDAQ:AAPL), Microsoft (NASDAQ:MSFT) and Exxon Mobil (NYSE:XOM) are the top three holdings.

From a sector look, information technology takes the top spot with more than one-third share, followed by consumer discretionary (18%), health care (15.3%) and industrials (14%). The product has amassed $1.1 billion in its asset base and charges just 15 bps in annual fees from investors. Average trading volume is moderate at around 102,000 shares per day. The ETF is up 13.1% over the past one year.

PowerShares S&P 500 High Quality ETF (NYSE:SPHQ)

This fund tracks the S&P 500 High Quality Rankings Index, a benchmark of S&P 500 stocks that have solid long-term growth as well as stable earnings and dividends. This approach has resulted in a basket of 135 stocks with none holding more than 1.38% of total assets. Yum! Brands Inc (NYSE:YUM), Emerson Electric Company (NYSE:EMR) and IBM (NYSE:IBM) are the top three elements in the basket.

The fund is skewed toward industrials at 26.9% while consumer staples and consumer discretionary round off the next two spots with over 18% share each. The product has managed $520.7 million in AUM and trades in good volume of 153,000 shares per day on average. Expense ratio came in at 0.29%. SPHQ returned 12.1% over the past year.

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