Rising costs are crimping profit margins for S&P 500 companies, which peaked in 3Q 2018 and are now falling for the first time since 2015, per the Financial Times. With the U.S. unemployment rate at its lowest level since the 1960s, labor costs are surging. "Data indicate that the tight current labor market is presenting an exceptional challenge to corporate managers," as Goldman Sachs observes in their recent "U.S. Thematic Views" report.
Goldman recommends 50 stocks with below-average labor costs, including these 10: Monster Beverage Corp. (MNST), ONEOK Inc. (OKE) , Lincoln National Corp. (LNC), Synchrony Financial (SYF), Unum Group (UNM), Anthem Inc. (ANTM), Align Technology Inc. (ALGN), AES Corp. (AES), and Host Hotels and Resorts Inc. (HST), and Discover Financial Services (DFS).
10 Stocks That Can Survive Rising Labor Costs
(Labor Costs Compared to Revenue)
- Monster Beverage, 4%
- ONEOK, 2%
- Lincoln National, 4%
- Synchrony, 4%
- Unum, 5%,
- Anthem, 4%
- Align Technology, 8%
- AES, 5%
- Host Hotels and Resorts, 1%
- Discover Financial, 7%
- S&P 500 median stock, 13%
Source: Goldman Sachs, "Where to Invest Now," March 2019
Significance for Investors
A recent survey by the National Association for Business Economics shows a record 58% reporting rising wage costs, but only 19% increased prices as a result, the FT reports. Goldman thus recommends stocks with pricing power, the ability to pass along cost increases to consumers without offsetting declines in sales volume.
An alternative approach is to seek stocks, such as those listed above, that are relatively insulated from the negative effects of cost inflation, especially wage inflation. "Stocks with low labor costs should also outperform as inflation expectations rise," Goldman writes.
Align Technology developed the Invisalign system. Computerized 3D printing technology creates clear, custom-fitted plastic teeth-straightening trays, a cosmetically superior alternative to braces. Over 6 million people worldwide have used Invisalign through Sept. 2018, per the company. Consensus estimates reported by Goldman anticipate 23% sales growth and 4% EPS growth in 2019.
Roughly 300 million people worldwide "could benefit from straightening their teeth, but are unlikely to seek treatment through a doctor's office," per a filing from Align Technology quoted by USA Today. This has spawned competitors such as SmileDirectClub and Candid that offer cheaper alternatives directly to consumers. Invisalign addresses a broad spectrum of tooth alignment problems, but these alternatives are suitable only for minor or moderate issues.
Monster Beverage is in the expanding market for energy drinks. Net sales in 4Q 2018 were up by 14.1% year-over-year (YOY), while EPS rose by 22.7%, per the company. Per consensus estimates cited by Goldman, projected full year 2019 growth rates are 10% for sales and 13% for EPS, versus respective figures of 4% and 6% for the median S&P 500 stock.
The Coca-Cola Co. (KO) has a 17% stake in Monster and is its principal distributor. However, the beverage market has relatively low barriers to entry apart from winning shelf space at retailers and is marked by fads. Indeed, Coke reportedly is developing its own line of energy drinks, which Monster argues is in breach of their agreement, per Beverage Daily.
While Goldman's low labor cost strategy makes sense given the macro environment of low unemployment and rising wages, other factors inevitably will affect the performance of these stocks. For example, Align Technology's expenditures on R&D and marketing are still growing rapidly, reducing the bottom line impact of increased sales revenue. Monster, meanwhile, may be undercut by its supposed partner, Coke.