From time to time, investors show a marked preference for certain types of company. If they’re feeling nervous, they’ll gravitate towards dull-but-predictable companies such as utilities; if they’re feeling optimistic, they’ll take a chance on high-growth areas. If they’re feeling really adventurous, they might rummage about in unloved parts of the stock market looking for undiscovered gems.
What makes a company ‘quality’?
‘Quality’ companies usually do well when investors are worried about the economic outlook. The assumption is that these stock market stalwarts can be relied on to deliver strong earnings and solid dividends through thick and thin. However, more recently and against expectations, this part of the market has been significantly out of favour, with its premium to the rest of the market evaporating.
This has meant that high-profile ‘quality’ investors such as Terry Smith at Fundsmith, or Nick Train at Lindsell Train have had a difficult run of performance. The question is whether this brings an opportunity for investors to top up on high-quality companies at lower prices.
The definition of a quality company is fluid, but they tend to be companies with strong ‘moats’ that help protect their profits from competitive pressures. This might be strong brands, recurring, subscription-based cashflows, or specific intellectual property. This is hard for their competitors to replicate. The theory of quality investing is that stock markets will often underestimate the value of these moats.
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Why software, healthcare and staples have been hit hard
Quality companies have had a difficult period over the past 12 to 18 months. Many of the sectors that are the natural hunting ground for quality managers have been under fire – albeit for different reasons. That includes software, healthcare and consumer staples companies.
Software companies are a natural home for quality managers. They usually have high margins, recurring revenues and strong intellectual property. However, 2026 has seen a ‘SaaS-mageddon’. Investors have been spooked by the potential for software companies to be disrupted by artificial intelligence, which has triggered a huge sell-off.
The S&P Software & Services Select Industry index – a proxy for the software sector – dropped over 25% from the start of the year to the end of March*. The catalyst was the launch of Anthropic’s Claude tool, with investors fearing it would undermine the business model of software and data-focused businesses across multiple sectors. Even behemoth Microsoft didn’t prove immune, with its share price down over 14% since the start of the year**.
Other quality sectors have also been under pressure. Healthcare has struggled with worries over pricing, as Donald Trump has sought to bring down the cost of medicines in the US, and concerns about potential changes to US healthcare policy under health secretary Robert F Kennedy Jr. Consumer staples companies have been hit by the GLP-1 phenomenon, with investors worried about the impact of weight loss drugs on profits for the large food and drink manufacturers.
But, are there bargains among these beaten-up sectors?
Jonathan Miller, client portfolio manager on the team managing the GQG Partners US Equity fund, argues that healthcare, consumer staples and utilities are at record lows in terms of exposure in the US index, and in some areas the share price falls may have been overdone.
On consumer staples, for example, he says: “The claim that GLP-1s could impact consumer staples may hold some truth, but in our view the market is being overly punitive and is ignoring these companies’ proven resilience and adaptability. Staples giants like Unilever and Danone have faced shifting trends before — from the backlash against sugary drinks to the rise of health-conscious eating — and emerged stronger by innovating.
“We think their massive advertising and innovation budgets, retailer partnerships, and control over prime shelf space give them a competitive edge over would-be new entrants. If GLP-1s shift consumption toward high-protein or functional foods, we believe companies like Danone, with expertise in dairy and nutrition, are well positioned to capitalise.”
It’s a similar picture for some of the software companies. The IFSL Marlborough Multi-Cap Growth fund increased its positions in Capita and RELX in March***. Both companies had been caught up in the software rout and manager Richard Hallett sees opportunity there. They continue to fulfil the fund’s criteria of “quality companies with strong cash flows, pricing power and resilient earnings growth,” he says.
Alison Henry, investment specialist in Japanese equities at Baillie Gifford, says investors may also be too pessimistic on the outlook for some software companies amid fears over AI disruption. She points to Money Forward, a software-as-a-service company held in the Baillie Gifford Japanese fund, which has been caught up in the recent ‘SaaS-mageddon’ sell-off. However, she says the company is embracing AI rather than being threatened by it, retraining staff internally to become AI specialists and positioning itself to benefit from the shift.
Microsoft is now the third-largest holding in the M&G Global Dividend fund, at 6%, with manager Stuart Rhodes topping up the holding in late 2025****. He can invest across quality, asset-rich and high-growth companies, and says that his quality weighting is high relative to history. Nevertheless, investors still need to be selective in this part of the market.
He says: “We have been increasing exposure to defensive quality as valuations became more palatable following a savage de-rating. Being selective remains paramount, however, as the quality segment of the portfolio must deliver on its designated role: being utterly dependable in the toughest of times. Our holdings in quality therefore must be highly reliable in their defensiveness or offer the comfort of value to protect any potential downside. We are encouraged by the opportunity we see in a variety of world-class businesses and taking advantage of attractive entry points we have not seen in many years.”
Selectivity remains crucial
Nevertheless, this isn’t quite the same as saying that all quality stocks are undervalued. There are still sectors and individual companies that appear to be under pressure. The latest earnings season has been difficult for the healthcare sector, for example. It is the only sector to see a setback in earnings over the first quarter of the year^. There are some bargains among quality companies, but discernment is required.
