10 Stocks That Are Crushing The Market As Costs Hit A Breaking Point

While many investors are focused on the negative impacts of tariffs and the U.S.-China trade war on corporate profits, they may be overlooking another sizable threat, which is rapidly rising labor costs. The median company in the S&P 500 Index (SPX) pays out 13% of its revenues in the form of employee compensation, and these costs grew by 3% in 2018, the fastest pace during the current economic expansion, which began in June 2009, Goldman Sachs reported this week.

Goldman believes that stocks with lower than average labor costs as a percentage of sales are well-positioned to outperform in this environment. Among the 50 stocks in their low labor cost basket are 10 that have risen by 21% to 62% this year, crushing the S&P 500, which is up by 19.4% through July 10. Many of them may be positioned to keep on doing so.

They are: Viacom Inc. (VIAB), whose labor costs are just 2% of sales; Dish Network Corp. (DISH): 6% of sales; Under Armour Inc. (UAA): 3% of sales; PulteGroup Inc. (PHM): 5% of sales; Monster Beverage Corp. (MNST): 5% of sales; Aflac Inc. (AFL): 3% of sales; Align Technology Inc. (ALGN): 8% of sales; Seagate Technology PLC (STX): 3% of sales; McKesson Corp. (MCK): 1% of sales; and AmerisourceBergen Corp. (ABC): 1% of sales. Goldman's labor cost calculations were as of July 3, 2019.

Significance For Investors

 "Labor issues currently represent a larger challenge for businesses than they have in decades," Goldman says in their U.S. Thematic Views report, "Labor costs and US Equities: Under pressure." They note that corporations are registering a record level of concern about labor costs in response to surveys.

"Stocks in our Low Labor Cost basket, which are relatively insulated from rising wages, allocate just 5% of revenues to labor costs [for the median stock in the basket] but trade at a 39% P/E discount to our High Labor Cost basket," Goldman observes. The median stock in the low labor cost basket had a forward P/E of 13 times estimated next 12 month earnings as of July 3, 2019, versus 21 times for the median stock in the high labor cost basket and 18 times for the median stock in the S&P 500.

The current economic expansion began in June 2009, which represented the end of the last recession, according to the National Bureau of Economic Research (NBER). The U.S. unemployment rate is now only 1/10 of a percentage point and one month removed from its lowest level in 50 years, the report indicates. "Due in part to these wage pressures, the profit margin compression that occurred in 1Q 2019 should continue during the remainder of the year, weighing on EPS growth," Goldman says.

To be sure, not all of these low labor cost stocks are sure bets to thrive in the coming year. DISH Network, the highest flying of the stocks listed above, is a provider of pay TV services, including delivery via satellite and streaming over the internet, the latter offered by its Sling TV service. Its 62% YTD gain in 2019 comes despite consensus estimates cited by Goldman that anticipate negative sales and EPS growth in 2020, as well as a net profit margin of only 3%.

However, speculation is rife that DISH may be in a position to profit from the proposed merger between wireless providers T-Mobile US Inc. (TMUS) and Sprint Corp. (S). Approval of the merger may require the divestiture of wireless spectrum by the two carriers, and perhaps also Sprint's Boost Mobile prepaid business, MarketWatch reports. The upshot is that DISH may be able to enter the wireless market by picking up existing assets at bargain prices. If this scenario does not play out, DISH stock is apt to give up its gains.

Looking Ahead

Also, Goldman notes that many stocks in its low labor cost basket have lagged the market in recent months, "mirroring the negative growth outlook signaled by falling breakeven inflation." However, if wage costs grow by an additional percentage point per year, they estimate that EPS for the S&P 500 will drop. And that environment would benefit low labor cost stocks.

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