One question that I am repeatedly hearing from investors is this: in an expensive market, where can I find opportunities? My answer has surprised them: look at quality stocks. Here’s why.
Let’s first define what quality stocks are. MSCI indices say they’re shares with attributes such as high returns on equity, predictable earnings growth and low debt levels.
The attributes make sense. A high return on equity suggests a company has a competitive edge that allows them to earn significant profits on the shareholder money invested in the business. Predictable earnings also denote an edge that is sustainable and repeatable. Finally, low debt levels imply a company that can grow without taking on too much leverage – and lower leverage makes earnings less volatile and reduces overall business risk.
Global quality has lagged
Globally, only one in five companies qualify as quality stocks. Over the past four decades, these stocks have handily beaten global indices and other types of investing such as value and growth. And they’ve done it with less volatility.
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For this reason, quality stocks have historically been highly priced, at a premium to the market.
That’s less so today as quality stocks have trailed the market over the past year. In 2025, quality trailed global stocks by around 6%, and in developed markets, it was closer to 15%. These stocks were left behind as investors bid up more speculative stocks.
Australian quality stocks have trailed too
Defining quality stocks in Australia is a little fuzzier. There are three indices that track quality shares here – the Solactive Australia Quality Select Index, the S&P/ASX Quality Index, and the MSCI Australia IMI Quality Index.
In 2025, total returns from these indices differed markedly: Solactive’s rose 12%, S&P’s 5% and MSCI’s 3% (this was price only as they don’t give total returns).
Why the big gaps in performance? Well, each of them filters different characteristics for quality stocks, and I’m not sure any of them get it close to right.
For instance, Solactive’s Australian Quality Select Index has the following stocks in the top 10.
Source: Solactive
Perseus Mining shouldn’t be in a quality index, in my view. It’s a capital intensive gold miner that has a mixed track record through mining cycles.
Also, the inclusion of banks like ANZ, NAB and Westpac are questionable too. They sell commodity products and have low returns on equity (ROEs). For instance, ANZ’s ROE was just 8% in its most recent 12 month results, which is below its cost of capital and lags the ASX 200’s ROE of close to 10%.
So, Solstice’s quality index defines quality very differently to what I would.
The returns from quality stocks in Australia over the past 12 months are more likely nearer those of the S&P and MSCI indices. This makes sense because the ASX 200’s total returns were 10% in 2025, with resources up 36%, financials higher by 12%, while industrials increased by just 4%. Most of what I would deem as quality stocks fall into that industrials category.
For example, if I screen for ASX 200 stocks with ROEs above 18% in 2025, it comes up with the following list, excluding mining-related companies.
Source: Morningstar
Just about all these stocks would fit my definition of quality, barring Qantas (capital intensive), Orora (no competitive edge?), and perhaps James Hardie (management is doing its best to destroy a fine business).
Many of these stocks significantly underperformed the ASX 200 index in 2025:
- REA -21%
- GQG -16%
- Aristocrat -15%
- Pro Medicus -12%
- Technology One -11%
- Woolworths -4%
- JB Hi Fi +4%
- The Lottery Corporation +4%
- Resmed +5%
*Price terms only
Among these stocks, and other quality ones, may lie some great, even generational opportunities for investors. From the list, REA, Resmed, Aristocrat, Woolworths, and The Lottery Corporation look most interesting.
The best ways to invest in quality stocks
What are the ways to get access to quality stocks? Of course, you can buy the shares directly.
Many prefer to own ETFs nowadays. VanEck’s MSCI International Quality ETF (ASX: QUAL) invests in quality shares outside Australia. Betashares Global Quality Leaders ETF (ASX: QLTY) invests worldwide in quality. Meanwhile, VanEck’s Morningstar Wide Moat ETF (ASX: MOAT) owns quality stocks in the US.
For Australia, the options are more limited. Betashares has the Australian Quality ETF (ASX: AQLT) but it’s based on the aforementioned Solactive Australia Quality Select Index, which I view as having serious limitations.
I think fund managers who invest in quality stocks, and have consequently underperformed of late, may be worth considering too. Aoris Investment is an Australian-based global fund managers with a great long term track record of investing in quality stocks. Airlie Funds Management focuses on Australian stocks and has smart minds running it. There’s also AFIC, a listed investment company that had a terrible year yet owns a portfolio full of quality stocks, many of them mentioned above.
Disclosure: VanEck is a Firstlinks sponsor, as is Airlie via Magellan Investment Partners.
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Rob Almeida of MFS grabs onto a similar theme as my editorial above, suggesting that while cyclical stocks are hogging the headlines, 'compounders' may be on sale, and their resilience should shine through in the long term.
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In my article this week, I look at Ray Dalio's unique take on 2025 - dominated by a collapse in the value of money and a move away from US assets - and what he thinks it means for markets this year and beyond.
James Gruber
Also in this week's edition...
Some industry experts suggest Division 296 may double-tax franking credits but Tony Dillon says that's not the case, and explains why.
Auscap's Tim Carleton says Macquarie is becoming a significant competitor to the Big 4 banks in home loans and that brings earnings risk to the majors that isn't currently priced into the market - a stark warning for anyone who owns any of the Big 4, which includes just about every Australian.
There's been a lot written about AI but less about what the economic consequences could be from a boom, bust, or something in between. Schroders' David Rees breaks down the diffferent scenarios for the US and global economies.
When investing in A-REITs, many people think they're owning passive rental vehicles. But Quay Global Investors says that's mistaken, as development and funds management companies increasingly dominate the index, resulting in greater cylicality and volatility.
We care a lot about the price of milk at the supermarket, yet think little about the industry behind the products on the shelves. Harrison Stewart says dairy farming deserves greater attention as an alternative asset class.
Lastly, in this week's whitepaper, Neuberger Berman identifies five themes that will drive markets in 2026.
Curated by James Gruber and Leisa Bell
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