Forecasts of 2019 earnings growth for companies in the S&P 500 Index (SPX) have a particularly wide variation, and Goldman Sachs sees this as an "opportunity for fundamental investors." They expect that the key driver of gains for equity investors will shift from beta, or the impact of broad macro forces, to alpha, or company-specific fundamentals. "We believe the market has priced a stabilization in US economic growth and a patient Fed," they write in a recent report.
Goldman has developed a list of 25 S&P 500 stocks that are most likely to be driven by company-specific factors. Based on a metric called the "dispersion score," these seven stocks are in the top ten: Align Technology Inc. (ALGN), Nektar Therapeutics (NKTR), Monster Beverage Corp. (MNST), Akamai Technologies Inc. (AKAM), Nvidia Corp. (NVDA), Ulta Beauty Inc. (ULTA), and Abiomed Inc. (ABMD).
7 Fundamental Stock Picks
(Goldman Sachs Dispersion Scores)
- Align Technology, 15.3
- Nektar Therapeutics, 13.6
- Monster Beverage, 8.9
- Akamai, 8.0
- Nvidia, 7.9
- Ulta Beauty, 7.5
- Abiomed, 7.5
- Median stock in top 25, 6.0
- Median stock in the S&P 500, 1.5
Source: Goldman Sachs
Significance for Investors
As evidence of the wide variation in 2019 consensus EPS estimates for the S&P 500 companies, Goldman notes that 43 have projected growth of 20% or more and 19 have expected declines of 20% or more. Meanwhile, the median S&P 500 stock is anticipated to experience an EPS increase of 6%.
To determine the impact of company-specific fundamentals on a given stock, Goldman looked at the last six months of returns and filtered out the effects of "market, sector, size, or value factors." They next calculated "firm-specific risk," defined as the forecasted volatility, over the next six months, of the proportion of total returns that are driven by company-specific fundamentals.
The "dispersion score" is the "firm-specific risk" times the square root of the percentage of trailing returns that were company-specific. This theoretic framework was presented in Goldman's US Weekly Kickstart report dated Feb. 15, 2019.
Goldman hastens to warn investors that the stocks on their list offer significant risk both to the upside and to the downside. Three of the seven stocks listed above have forecasted 2019 EPS growth rates that are significantly above the S&P 500 median of 6%: Ulta Beauty at 17%, and both Akamai and Monster at 13%. The other four have below-average, including negative, EPS growth figures: Align at 4%, Abiomed at 3%, Nvidia at -18%, and Nektar at a stunning -136%.
Align and Abiomed have projected revenue growth rates of 23% and 27%, respectively, suggesting that costs are expected to grow significantly as well. Nvidia and Nektar are projected to endure sales declines of 6% and 80%, respectively. Goldman's report does not say so directly, but these four stocks may offer opportunities for significant gains if the consensus estimates prove to be unduly pessimistic, and if the companies thus deliver positive earnings surprises in 2019.
By the same token, the above-average expectations for the other three stocks suggest that they may have significant downside risk. Meanwhile, a report from Morgan Stanley also makes the case for shifting from macro drivers to more company-specific factors in making equity investment decisions right now.
Succeeding at stock picking requires great skill or great luck. The degree of difficulty is illustrated by the fact that only 24% of 4,600 actively-managed mutual funds studied by Morningstar beat their benchmarks over the past decade.