Corporate profit margins are under siege from a number of factors, including increasing labor costs, general inflation, and rising interest rates. "Companies expanding margins are scarce given late cycle dynamics," Goldman Sachs observes in their recent "Where to Invest Now" report.
Nonetheless, Goldman finds that these stocks in the S&P 500 Index (SPX) are among those expected to increase their net margins by at least 50 basis points (bps) annually in 2019 and 2020: Netflix Inc. (NFLX), TripAdvisor Inc. (TRIP), Tapestry Inc. (TPR), Becton Dickinson & Co. (BDX), Abbott Laboratories (ABT), Lockheed Martin Corp. (LMT), Keysight Technologies Inc. (KEYS), NetApp Inc. (NTAP), Microsoft Corp. (MSFT), and Vulcan Materials Co. (VMC).
10 Companies With Fattening Net Margins in 2019
- Netflix: 235 bps growth
- Vulcan: 208 bps growth
- Keysight: 203 bps growth
- NetApp: 145 bps growth
- Becton Dickinson: 117 bps growth
- TripAdvisor: 112 bps growth
- Tapestry: 91s bps growth
- Abbott Labs: 85 bps growth
- Microsoft: 83 bps growth
- Lockheed Martin: 63 bps growth
Source: Goldman Sachs
Significance for Investors
Microsoft, Netflix, and TripAdvisor present illustrative examples. Microsoft is a leading developer of software for personal computers and also a major player in the growing market for cloud computing services, and currently the largest S&P 500 company by market cap. Goldman projects that Microsoft's net profit margin will reach 28% in 2019 and 30% in 2020. By comparison, the comparable figures for the median S&P 500 company, excluding financials and utilities, are 12% and 13%. Forecasted EPS growth rates for the same years are 16% and 20%, versus 8% and 11% for the S&P 500, again excluding financials and utilities.
A trend among technology companies has been to move away from one-time sales of hardware and software to a subscription business model that produces recurring streams of revenue, and thus produce more stable growth. Goldman indicates that Microsoft has increased its recurring revenue from just over 40% of total sales in 2014 to 61% in 2018, while projecting that the figure will reach 71% by 2022.
Netflix is a leading provider of video streaming services. Net profit margins are estimated to reach 10% in 2019 and 13% in 2020, while EPS are expected to jump by 62% and 58% in these years. Netflix also appears in Goldman's basket of strong balance sheet stocks, based on Altman Z-Scores that indicate a low risk of bankruptcy, one of their major themes in the face of rising interest rates.
While Netflix has a high debt load and a lofty valuation, the company is adding subscribers at a pace that makes it a "long-term secular winner," per a recent UBS research report. Netflix spends heavily on producing original content available only to its subscribers, and this is widening the "moat" between it and many competitors, UBS observes.
TripAdvisor is a website best known for compiling readers' reviews of hotels, restaurants, and attractions, but it generates revenue from travel reservation services. Net margins are expected to reach 9% in both 2019 and 2020, with EPS projected to grow by 21% and 14%. It appears in Goldman's strong balance sheet basket, but also in the firm's high labor cost basket, with projected 2019 labor costs at 21% of revenue, versus 14% for the median S&P 500 stock. Investor confidence has been bolstered by a rebound plan that is lowering its cost base and returning revenues to a growth path after extended declines, The Motley Fool reports.
Looking for stocks with high profit margins makes particular sense in macro environments marked by rising costs. However, Goldman's projections of future margins may or may not be realized. Moreover, even if they are, that is no guarantee of price appreciation in these stocks, especially if a general market downdraft depresses stock valuations across the board.