Three companies I’m backing in my Quality Shares Portfolio

Most companies are, by definition, mediocre. Some are good. Fewer still are great. And a tiny minority are truly exceptional. These are the ones I want to own. 

I’m looking to invest in durable, adaptable and – above all – resilient businesses. Those selling critical goods and services, with high levels of recurring income from loyal customers. 

I believe the three companies below, in the Quality Shares Portfolio since launch (March 2023), pass these tests with flying colours. 

RELX plc (LSE: REL)

Its name may not set the pulses racing, but you’d be hard pushed to find a higher-quality UK-listed business than RELX.

RELX is one of the world’s leading data experts. Its data, tools and analytics help insurers price risks, governments combat fraud and banks comply with anti-money laundering regulations. These aren’t the kind of things you stop doing in an economic downturn. Added to RELX’s long-term contracts and high levels of recurring revenue, it lends great predictability and resilience.

RELX also benefits from an excellent competitive position. Not only is the quality of its data superb, but its solutions are deeply embedded in customer workflows, leading to high switching costs. Add RELX’s brand strength, customer relationships, reputation and global scale and you get quite a formidable combination. Put it this way: I wouldn’t want to compete with it.

Competitive advantages like these can often breed complacency, but RELX has not rested on its laurels. 

Over the last 15 years, it has invested heavily in innovation, launching increasingly sophisticated data analytics and tools. As a result, electronic revenues have grown steadily, while lower-quality print-based revenues have significantly reduced.

RELX revenue by format

These investments are paying off. Last year, RELX grew underlying revenue by 8% – twice as fast as a decade earlier. Profit margins also increased strongly, aided by a bounce back in its events business, leading to a 13% rise in adjusted operating profit. 

2024 seems to have started in a similar vein. With the evolution towards faster-growing analytics continuing, its growth prospects have never looked better to me.

Roper Technologies Inc (NASDAQ: ROP)

Once an industrial giant – selling anything from pumps to stoves and garden equipment– Roper has undergone a significant transformation in recent years. 

Slower-growing and more cyclical industrial businesses have been sold with proceeds redeployed into acquisitions. Today, Roper is a highly diversified conglomerate of 27 high-quality software and technology businesses, with annual sales ranging from less than $100 million, to over $500 million.

On the surface, these companies are quite different. One provides billing software for legal firms, another sells single-use bronchoscopes into hospitals. But they all share similar characteristics that should make them extremely resilient.

All Roper’s businesses occupy market-leading positions within a niche, helping keep a lid on competition. The software and technology are critical and deeply embedded in customer operations, making switching difficult and expensive. In addition, a large portion of Roper’s sales are recurring and derived from defensive end markets, like education, healthcare and insurance. 

This business model is wedded to an entrepreneurial culture that eschews politics and embraces candour. Roper’s companies are kept independent and given considerable autonomy – the leaders are trusted to make decisions and, crucially, held accountable for the outcome.

The results speak for themselves. 

Roper is enjoying higher margins and stronger organic revenue growth than at any time in its history. In 2023, it reported another year of strong growth, with total revenue growing by 15%, with around half coming from existing businesses (organic revenue growth of 8%).

Roper revenue growth profile

Acquisitions have been – and remain – a key part of Roper’s growth strategy.

It recently acquired Procare Solutions, a leading provider of software to childhood education centres, for a net purchase price of $1.75 billion. 

Procare looks like an excellent business to me. Its software is deeply embedded into customers’ operations, performing critical functions and it occupies a market leading position within its niche, benefitting from strong customer relationships. Procare also has excellent growth prospects, with Roper targeting organic growth of around 15% for this business over the long-term. 

Overall, I think Roper is the definition of a strong business getting stronger and I couldn’t be more excited by its long-term prospects. 

Diploma plc (LSE: DPLM)

Many industrial businesses have struggled in a weakening economic environment. Diploma is an exception, because it is no ordinary industrial distributor.

Diploma supplies critical products, funded from customers’ operating rather than capital budgets. Whether its low-voltage cables going into data centres, seals going into construction equipment, or instruments used for life-saving surgeries, the common thread is that Diploma’s customers often can’t function without them.

Diploma is much more than just a product supplier, however. Its businesses provide deep technical support, next-day delivery and customised solutions. This value-add service offering makes it a long-term partner to its customers and translates to excellent pricing power, margins and cash flow.

Diploma has shrewdly redeployed this cash into acquisitions, to fortify existing niches, and gain a foothold in exciting new markets. The success of this acquisition strategy is evidenced by Diploma’s very high returns on capital employed of around 20%.

Diploma Financial KPIs

First-half results from Diploma in May show it continues to fire on all cylinders (or should I say seals).

Revenue increased 10%, with half coming from existing businesses and the rest from acquisitions. Profit margins rose, leading to 14% growth in adjusted operating profit. And the cash rolled in, with free cash flow (cash available after interest, tax and capital expenditures) rising by 28%. As a result, Diploma increased its full-year revenue and profit guidance.

Diploma has also recently completed two very interesting acquisitions – Peerless Aerospace in March (for £236 million), and PAR Group in May (for c. £38 million). I believe both are high margin businesses that are very complementary to Diploma’s existing operations, with excellent long-term growth prospects. And both were acquired for around 7x forecast FY24 operating profit, which I deem a compelling valuation.

This says to me is that Diploma’s acquisition strategy is only just getting going. With plenty of white space left on the map, and proven acquisition credentials, Diploma looks well placed to grow for many years to come.