7 Stocks That Can Lead as Corporate Margins Plunge

Corporate profit margins are under increasing pressure, as inflation and tariffs push up costs. In particular, an exceptionally tight labor market is causing wages to rise at an accelerating rate. "Stocks with the lowest labor cost exposure should outperform as wages continue to rise," Goldman Sachs says in their recent U.S. Macroscope report, noting that a "dovish Fed encourages strongest wage growth in a decade."

Among the 50 stocks in the low labor cost basket assembled by Goldman are these seven: Under Armour Inc. (UAA), Hanesbrands Inc. (HBI), ONEOK Inc. (OKE), Colgate-Palmolive Co. (CL), IPG Photonics Corp. (IPGP), Amphenol Corp. (APH), and Unum Group (UNM). This is the first of two articles that Investopedia will devote to Goldman's report.

7 Proven Leaders

(Labor Costs as % of Revenue)

  • Under Armour: 3%
  • Hanesbrands: 5%
  • ONEOK: 2%
  • Colgate-Palmolive: 6%
  • IPG Photonics: 12%
  • Amphenol: 12%
  • Unum: 5%
  • Median stock in basket: 6%
  • Median S&P 500 stock: 14%

Source: Goldman Sachs

Significance for Investors

Goldman's low labor cost basket is sector-neutral, with representatives from all 11 S&P 500 industry sector. Their methodology also has the effect of placing seven stocks in the basket of 50 that actually have labor costs as a share of revenue that are equal to or greater than the median for the S&P 500 as a whole. Additionally, note that Goldman's calculations are based on full year 2017 financial reports, given that full year 2018 data was not yet available for all S&P 500 companies.

Goldman cites the most recent survey by the National Association for Business Economists (NABE) as evidence of the increasing pressure on profit margins from wage increases. A record 58% of respondents report rising labor costs, but only 19% indicated that their companies had raised their prices to customers.

From early 2016 through mid-2018, Goldman indicates that their low labor cost strategy outperformed the S&P 500 by more than 20 percentage points, a period in which "breakeven inflation" rose from 1.2% to 2.2%. However, it underperformed by 7 percentage points in the second half of 2018, during which time market expectations about inflation and economic growth were declining. For the year-to-date through Feb. 8, 2019, the basket outperformed by 3 percentage points.

Going forward, Goldman expects the low labor cost strategy will continue to outperform, given their projection that the unemployment rate, which is already below most measures of theoretic full employment, will drop from its current reading of 4% to 3.6% in the second half of 2019. Their economists estimate that average wages are currently rising at an annualized rate of 3.4%, a high for this economic cycle.

Hanesbrands has been an especially strong performer in 2019, with its stock up 49% YTD. Its lengthy list of well-known labels includes, among others, Hanes, Polo Ralph Lauren, Champion, Playtex, Bali, Donna Karan, DKNY, Gear for Sports, Wonderbra, and L'eggs. Consensus sales and EPS growth estimates are just 1%, with a low forward P/E of just 10, per Goldman.

However, Hanes has been identified as an attractively-valued turnaround play by Seeking Alpha. The company is reducing a debt load that was added during a brand acquisition binge, is expanding international sales, particularly with its Champion label, and offers a safe dividend, per that report. The yield is currently 3.2%.

ONEOK, founded in 1906, operates natural gas pipeline and storage facilities, mainly in the U.S. Rocky Mountain and mid-continent regions. The stock is up by 25% YTD, and offers an attractive dividend yield of 5.3%. Based on strong "recession-resistant cash flows," ONEOK is poised to deliver long-term dividend growth while trading at a large discount to fair value, according to Seeking Alpha.

While ONEOK has a forward P/E of 23 times projected earnings, its PEG ratio, which compares the P/E to the projected growth rate in earnings, is only 0.61, per Thomson Reuters as reported by Yahoo Finance. This suggests undervaluation.

Looking Ahead

As long the economy and employment keep expanding, and the Fed remains dovish, labor costs are bound to continue rising, the low labor cost investment strategy will remain especially appropriate.

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