Strong balance sheets, profits, and disciplined growth can make a difference in rocky market environments. Invesco S&P 500 Quality ETF (SPHQ) is a great option for exposure to these stocks, and it has gotten better over time. It recently cut its fee and, in June 2016, switched to a more transparent index, which targets firms with strong cash flows and balance sheets. It should hold up better than most of its peers during market downturns and offer attractive performance over the long term. This strategy warrants an upgrade to a Morningstar Analyst Rating of Silver from Bronze.
The fund targets firms with strong profitability and balance sheets, which are important dimensions of quality. It targets 100 stocks from the S&P 500 with high return on equity, low growth in net operating assets during the most recent year (which is a proxy for capital expenditures), and low financial leverage. Firms with high return on equity and low growth in net operating assets tend to have high free cash flows, which they can use to fund dividend payments and share repurchases or pay down debt. Stocks that make the cut are weighted according to both the strength of their quality characteristics and their market capitalization, subject to a 5% cap.
Alex Bryan, CFA does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.