As we close out another year, we acknowledge it has been a difficult one for fundamental investors focused on quality companies.

How does Global Alpha define “quality”?  We mean companies with:

• Revenue growth with a high portion of recurring revenues
• Healthy profit margins
• Strong balance sheet
• Dividend paying
• Fair valuation, ideally below the market multiples

Instead of quality, the market has been fixated on size (the bigger, the better), liquidity (the more liquid, the better) and momentum (what goes up will continue to go up).

In other words, it’s a very speculative market.

Are we in a bubble?

Ruchir Sharma, Chair of Rockefeller International, asked that exact same question in his piece in Financial Times – The four ‘O’s that shape a bubble. He described four characteristics that define a bubble, “four Os”: overvaluation, over-ownership, overinvestment and over-leverage. In our view, today’s market checks all four boxes.

Overvaluation

Consider the S&P 500 price-to-sales ratio. It is currently at an all-time high, well above the peak reached during the tech bubble in 2000. The market is paying record prices for each dollar of revenue.

Source: Bloomberg

Over-ownership

US household stock ownership, as a share of financial assets, is also at record levels. According to Gallup, about 165 million Americans – roughly 62% of US adults – own stocks, an all-time high.

On top of that, foreign investors now hold a record share of US equities. The market has rarely, if ever, been this “crowded.”

Source: Federal Reserve

Sources: Federal Reserve, Macrobond, Apollo Chief Economist

Overinvestment

Technology investment has recently surpassed 6% of US GDP, eclipsing the previous record set in 2000. But the ultimate return on these investments is still uncertain, and there are signs that adoption is slowing rather than accelerating.

Over-leverage

We often hear about the enormous cash balances of the “Magnificent Seven.” However, much less attention is paid to the other side of their balance sheets: liabilities.

Amazon, Meta, and Microsoft are now net debtors, and they are increasingly financing capital expenditures with debt.

So, all four Os suggest a bubble. But who are we to know?

Surely, this time, it’ll be different! Right?

We recently looked at some assumptions underpinning the current enthusiasm and valuations.

The general consensus is that global semiconductor sales will grow at an annualized rate in the mid- to high-20% range over the coming decade.

During the strongest period until now – the 1990s, with the advent of the personal computer and the internet – annualized growth in semiconductor sales was about 15%.

Once again, the narrative is that “it’s different this time.”

What could deflate this bubble?
If we had to name one catalyst, it would be Nvidia, now the largest company in the world by market value, the most owned and traded stock globally, and the poster child for the AI wave.

What could go wrong with Nvidia?

In a word: Competition. More competition would likely mean lower market share, lower prices and lower profit margins.

Lessons from Novo Nordisk

The chart below shows the stock price of Novo Nordisk, which was the largest European company by market value just over a year ago. As a leader in GLP-1 “miracle drugs” used for weight loss and other health benefits, Novo Nordisk became the market’s favourite story.

As competition intensified and prices came under pressure, Novo Nordisk experienced a dramatic shift: its market value has dropped by 68% since its peak in June 2024.

What happened to this market leader?

Simple: more competition and lower prices. In 2024, Novo Nordisk earned €24.48 per share, up 29% from 2023. By mid-2024, analysts were expecting earnings of €30 per share in 2025, implying another 23% growth.

Source: Bloomberg

Source: Bloomberg

Instead, according to Bloomberg consensus estimates, earnings for 2025 will be around €23.38, a decline of approximately 4.5%, with a further decline expected in 2026. Novo Nordisk remains a great company, investors have just overpaid for it.

Lessons from Cisco

At the peak of the dot-com era, Cisco Systems was the company that defined the Internet age. It was the most valuable company in the world at the start of 2000, supplying the routers needed to handle internet traffic that was doubling every few months.

Despite that dominant position, Cisco’s stock only just regained its 2000 peak price last week – more than two decades later.

Source: Bloomberg

Looking at past trends, we do not expect Nvidia to maintain the market share and pricing power implied in current analyst forecasts. In our view (shaped by history that competition, regulation and changing narratives eventually catch up with even the most celebrated leaders), it is more prudent to diversify and pivot back to high-quality, reasonably valued companies with durable earnings and strong balance sheets

Lastly, we encourage you to read our previously published piece on quality: Time to take out the trash – Why high ROE matters in the long run. We breakdown how quality outperforms in the long-run and why it matters as an allocator.

We wish you a happy holiday season to you and your loved ones.

May 2026 bring peace and happiness to the world.

Of the five senses, vision is regarded as the most important as it allows us to navigate our environment, recognize the faces of our loved ones and read and watch to learn and entertain. But a good number of us do not have healthy eyes. According to the World Health Organization (WHO), at least 2.2 billion people globally suffer from near or distant vision impairment. The organization recognizes myopia as a significant public health concern given its rising prevalence around the world. A review of 276 studies (involving more than 5.4 million children from 50 countries across six continents) by the British Journal of Ophthalmology revealed that global prevalence of myopia among children and adolescents increased from 24% in 1990 to 36% in 2023 – one in three of all children and teens are nearsighted today. What is even more concerning is that myopia is starting earlier in children than before.

Prevalence of myopia by age group in 2000 vs. 2050, % of world population

Source: American Academy of Ophthalmology, BofA Global Research

The study predicted that approximately 740 million children and teens (more than half globally) will be myopic by 2050. American Academy of Ophthalmology in its 2016 article forecasted that by 2050, myopia would affect nearly half of global population. A more conservative projection this year puts the number at ~40% of global population – but it is clear that the world 25 years from now will have more than the 2.2 billion people in need of corrective lenses today.

Prevalence of myopia is not even across the world. Asia sees a higher prevalence (close to 40%) that is two to four times higher than that of other regions. East Asian countries – China, Taiwan, South Korea, Japan and Singapore – see much higher myopia rates, exceeding 80–90%, in their adolescent populations.

Source: ScienceDirect, Global perspectives on myopia and pathologic myopia: From environmental drivers to precision medicine

Primary drivers of myopia are genetics, near-work activities and lack of outdoor activities. A recent article in Progress in Retinal and Eye Research journal linked the high prevalences in the East Asian countries to educational systems characterized by intense academic competition, prolonged school hours and substantial homework assignments which significantly reduce opportunities for outdoor activities.

The WHO estimated that vision impairment cost the global economy an estimated USD411 billion in productivity loss, with only 36% of people with myopia having access to an appropriate intervention. Shanghai Conant Optical Co. Ltd. (2276 HK) in our Emerging Markets Small Cap Strategy seeks to address this global myopia pandemic. SCO, a sub-USD3 billion market cap company, is the second largest resin (plastic) optical lens maker in the world after EssilorLuxottica in terms of production volume. At its manufacturing locations across China and Japan, the company produced 209 million pieces to serve customers in over 90 countries around the world in 2024.

We believe SCO’s customer value proposition of value for money is especially effective in the product category of optical lenses. SCO’s high-index lenses (such as 1.74 and 1.67) are approximately half the price of comparable lenses from EssilorLuxottica, Hoya and Zeiss whilst providing the same level of vision correction. On product quality, SCO is an ODM (original design manufacturer) for all the previously mentioned global brands with various lens-coating options available. For the brand-conscious, it is “fortunately” very difficult to tell which brand of lens one is wearing. We are not surprised that the company is especially seeing strong demand in developing countries where its customer value proposition would be stronger. As a person who has been wearing glasses for the past three decades, I have found myself switching from the expensive Hoya and Nikon to much more affordable brands (including Asahi-Lite which is now owned by SCO), which have provided an identical visual experience – I have not looked back since.

China offers a significant room for growth, having entered the world’s largest short-sighted country in 2018, two decades after the company was established. Over 700 million people or roughly half the population in China are diagnosed with myopia. The prevalence of myopia is especially high in school-aged children – roughly 40%/70%/80% of students in elementary/middle/high school suffered from myopia according to a 2022 study published in Investigative Ophthalmology & Visual Science. Laser eye surgery is not an option for these youths, and they must rely on glasses for vision correction until they are older. SCO’s sales in China focus on higher-index lenses where competition is more limited and penetration is lower, and 80% of those sales are of its own brand. The company’s growth in China has been margin accretive given the higher mix of own brand and higher-index lenses.

The company is also involved in the development of AI/AR glasses with leading technology companies in North America and China. SCO as a partner to the technology companies makes sense, given SCO’s scale and cost competitiveness. We appreciate that SCO is trying to solve the problem of the global myopia pandemic, but do not doubt that AI/AR glasses offer the next leg of growth for the company.

After the “meme stock” frenzy of 2021 and a bruising surge of volatility in 2022, many investors assumed retail traders had finally stepped back. The story was neat: higher rates, tighter liquidity and fading stimulus would restore rationality to equity markets. We were not convinced and argued in February 2023 that speculative behaviour was more likely to adapt than disappear.

Fast forward to today, and the data suggest retail participation has not only persisted, it has become a defining force in short‑term market moves. Across the small‑ and mid‑cap universes, trading volumes in lower‑priced, lower‑quality names have surged, with roughly a quarter of daily volume now concentrated in stocks trading under $5, a share last seen at the peak of 2021’s speculation. This renewed activity has driven a striking rotation beneath the surface: low ROE and even unprofitable companies have periodically outpaced their higher‑quality, high‑ROE peers over short horizons.

In this weekly, we want to address two questions:

1. Why does high ROE – the best proxy for quality – matter when investing? And,
2. What does history tell us about the performance of companies with high ROE versus those with low or negative ROE?

What ROE really measures

Return on equity (ROE) is net income divided by shareholders’ equity; it tracks how efficiently a business converts owners’ capital into earnings. In practical terms, it tells you how many dollars of profit a company generates for every dollar of equity on its balance sheet. Conceptually, ROE links back to basic valuation logic: for a given starting multiple, a firm that can earn and reinvest at higher rates should grow intrinsic value and future dividends faster over time. A company that compounds book value at 15–20% per year for a decade ends up in a very different place than one compounding at 5%, even if both start at the same size and valuation.

High – and sustainably high – ROE typically reflects one or more durable advantages: strong pricing power, an advantaged cost position, valuable brands or networks, or business models that require relatively little capital to grow. This is why investors often group high-ROE companies under the broader “quality” or “profitability” factor. In other words, ROE is not just a ratio; it is often a shorthand for underlying business quality.

Why high ROE wins over time

History is clear: profitability and quality matter far more over multi-year horizons than they do over six month “junk” episodes. Portfolios tilted toward companies with high and persistent profitability have historically delivered higher average returns than portfolios concentrated in low profitability or unprofitable names, even after controlling for size and valuation.

There are three main reasons for this:

1. Compounding of retained earnings: High-ROE companies can reinvest a larger portion of each dollar of earnings at attractive rates. Over time, this drives faster growth in earnings per share and intrinsic value without requiring fresh capital from shareholders.
2. Resilience through cycles: Businesses that earn high returns on capital usually have competitive advantages that help them sustain margins and cash flows during downturns, which tend to show up as shallower drawdowns and faster recoveries.
3. Better capital allocation options: Management teams leading high-ROE franchises often have more flexibility: reinvest in the core, expand into adjacencies, pay dividends or buy back shares. Lower-quality companies, in contrast, often need to issue equity or debt simply to survive, diluting existing shareholders.

Short periods of outperformance by low-quality stocks can be sharp and uncomfortable, but they have historically been transient, while compounding fundamentals tend to dominate over longer horizons.

When you think about it, the lesson for long-term investors couldn’t be clearer: real wealth comes from investing in companies that steadily compound capital at high rates, not from jumping on every fleeting speculative surge. The junk rallies fade and quality compounding lasts.

Time to take out the trash – What really is a “junk rally”?

In a universe of over 12,000 companies within global small caps, not every balance sheet is one to admire. Our job as active managers is to find real quality – the companies that actually make money and know how to grow it – and to avoid the companies that are overleveraged, poorly managed or structurally unprofitable. Many of those “junk” businesses feel more like ticking time bombs than investments. So, what happens when these so‑called junk companies rally and drive index performance? Do we simply throw in the towel and chase them?

A junk rally is a period when the lowest‑quality stocks – often those with excessive leverage, negative earnings, high beta or heavy short interest – significantly outperform the broader market, particularly higher‑quality names. These episodes tend to be most intense and momentum‑driven in small caps, where smaller market caps and thinner liquidity allow collective enthusiasm and buying pressure to move prices disproportionately.

Junk rallies often arrive with a burst of excitement – usually from retail investors – as they rush into stocks chasing a story and paying little attention to fundamentals. To spread these stories, investors turn to platforms like Reddit, X or Instagram, using viral posts and online communities to build momentum. As more buyers join in, the rally feeds on itself, with price action attracting even more attention.

Common terms around these episodes include:

• Diamond hands: Investors who refuse to sell, convinced that holding long enough will eventually make them rich.
• Short squeeze: When heavily shorted stocks rise sharply, forcing short sellers to buy back shares to cover positions, which drives prices even higher.
• FOMO (“fear of missing out”): The anxiety investors feel when they believe they might miss a big gain if they do not act immediately.
• Pump and dump: When prices are hyped up – often by coordinated online promotion and early movers sell into the frenzy, leaving late buyers exposed when prices fall back.

These phrases rarely appear in institutional memos, but the behaviours behind them very much exist in our universe and often bring sharp, sudden volatility to stocks whose fundamentals have not changed.

How junk rallies behave in practice

Over the past five years, we have seen several junk rallies – wild bursts where low‑quality stocks suddenly take off. Each time, two features have stood out. First, these rallies are typically parabolic and short‑lived; trying to jump on the bandwagon after the move is underway is almost always a poor risk‑reward trade‑off. Second, they almost always mean‑revert back toward the market, making them more about timing and positioning than about sustainable value creation.

Normally, we would pay limited attention to these episodes. However, because these lower-quality stocks sit in our benchmark, big, synchronized rallies in some low-quality pockets can cause us to lag temporarily. That is exactly what happened in 2020, 2023, and again in 2025, when risk on sentiment sent the lowest quality corners of the market flying while our quality growth names took a back seat. As the excitement faded and fundamentals reasserted themselves, excess junk gains unwound and quality leadership reemerged.

Proof that low quality doesn’t last

Even without decades of data, recent episodes make the point: high ROE remains a long‑run winner. In the 2022 low‑quality rally, high‑quality stocks temporarily lagged as low‑quality names spiked and then sold off, but by the end of that six‑month stretch, the high‑quality cohort had again moved ahead. You saw a similar pattern in the quality rally of summer 2024, which lost steam by early 2025, and more recently in the post‑Liberation Day rebound, where relief from macro fears and crowded positioning turbocharged the most speculative, lower‑ROE parts of the market.

Once low quality lost steam, high quality rebounded faster

Low quality was ahead, but high quality protected during Liberation Day market correction

In the immediate aftermath of Liberation Day, low‑quality stocks rallied because the market shifted violently from fear to relief: investors moved quickly from pricing in severe recession and trade dislocation to betting on a softer outcome, and that swing in sentiment tends to benefit the most beaten‑up, highly levered and high‑beta parts of the market first. Positioning and mechanics amplified the move, as many lower‑quality names were heavily shorted and under‑owned going into the shock, so even a modest improvement in the macro narrative forced short covering and factor rebalancing, turbocharging returns in exactly the sort of speculative companies that typically lead junk rallies.

The current junk rally is showing signs of losing momentum, with lower-quality names starting to lag

Don’t hate the player, hate the game

Now that we’ve defined what junk rallies look like, let’s examine how they affect active management. As noted above, the post-Liberation Day period – when the MSCI World Small Cap Index surged 34.3% (CAD) between April 8 and October 31, 2025 – marked one of the strongest low-quality rallies of the past decade. During this time, market leadership – particularly in the United States – was dominated by lower-quality companies across a range of sectors. The AI and data centre trade became the theme of the year, driving performance regardless of valuations or ROE.

What you’ll almost never hear an investor say is that they’re overweight “junk.” It’s rare for anyone to deliberately focus on low-quality companies. As a result, low-quality rallies usually lead to short-term periods where active managers struggle to generate alpha. Looking at year-to-date and one-year returns, we’re seeing exactly that type of environment. With the MSCI World Small Cap Index ranking in the middle-to-high second quartile, about 60% of active global small-cap managers haven’t added alpha over the past year. Additionally, these periods usually come with a wide dispersion in manager returns, as portfolios with even modest exposure to the most speculative names tend to outperform sharply, while quality-focused strategies are left behind.

As we can see below, over the 7- and 10-year periods, global small caps remains an inefficient asset class – with more than 50% of active managers outperforming the MSCI World Small Cap Index.

What we’re trying to argue is that when these short periods of low quality take over, don’t hate the player, hate the game. The small cap market can be dysfunctional for short stretches, but over the long run, high-ROE companies almost always outperform their low-ROE peers.