Among the investment themes that Goldman Sachs recommends for the current macro environment is looking for stocks with fast-growing return on equity (ROE). "Our methodology was developed in a 30-year study using perfect information and then tested with forward-looking analyst estimates over the past seven years," Goldman states in a recent report, "Anatomy of Our US Portfolio Strategy Thematic and Sector Baskets."
Among the 50 stocks in Goldman's ROE growth basket are these eight: Whirlpool Corp. (WHR), Nike Inc. (NKE), Sysco Corp. (SYY), Union Pacific Corp. (UNP), Deere & Co. (DE), NetApp Inc. (NTAP), Cisco Systems Inc. (CSCO) and Everest Re Group Ltd. (RE). Details on their ROE metrics are presented below.
8 High ROE Stocks
(Forward ROE and Projected ROE Growth Rates)
- Whirlpool: 37% forward ROE, 36% ROE growth
- Nike: 49% forward ROE, 26% ROE growth
- Sysco: 81% forward ROE, 19% ROE growth
- Union Pacific: 37% forward ROE, 38% ROE growth
- Deere: 40% forward ROE, 30% ROE growth
- NetApp: 66% forward ROE, 40% ROE growth
- Cisco: 37% forward ROE, 46% ROE growth
- Everest Re Group: 11% forward ROE, 30% ROE growth
Source: Goldman Sachs
Significance for Investors
Decelerating economic growth is placing limits on revenue increases, while rising costs of production, especially wage costs, are putting pressure on profit margins. ROE expansion reflects either success in overcoming these headwinds, or shrinkage of the equity base.
The ROE growth basket includes S&P 500 companies that are covered by Goldman's own research analysts. Forward ROEs were computed from their forecasts of earnings and book value. Eligible stocks must have ROE growth between -50% and +50%, positive earnings in the last 12 months, a trailing price-to-book ratio (P/B) between 0 and 25, and forecasted forward ROE between -100% and +100%.
The median stock in the basket has a forward ROE of 19% and a projected ROE growth rate of 23%. For the median S&P 500 stock, the figures are 19% and 3%, respectively. The basket includes stocks from all 11 sectors of the S&P 500 and a variety of industries therein, such as household appliances (Whirlpool), apparel (Nike), food services (Sysco), railroads (Union Pacific), farm machinery (Deere), cloud computing services (NetApp), computer and communications networking hardware (Cisco), and insurance (Everest Re).
Cisco and Union Pacific have been among the best performers this year, up by 15.5% and 24.0% YTD, respectively, through the close on Feb. 19. By comparison, the S&P 500 gained 10.9% during this period.
Union Pacific has paid dividends for 120 consecutive years, and recently raised its quarterly payment by 10%, the fourth increase in the last six quarters. The company also is aggressively returning capital to shareholders through share repurchases, having spent $31.9 billion from 2007 to Feb. 6, 2019 to buy back 38% of its common shares, per a press release. Union Pacific's board has authorized repurchasing of up to 21% of its current shares outstanding through March 31, 2022. The company has a profit margin of 26%, per Yahoo Finance, and is noted for seeking continual improvement in operating efficiency.
Cisco is "the backbone of the internet" as The Motley Fool puts it, the leading supplier of switching and routing equipment critical to running the network itself and for providing various online services. A forward P/E ratio of 14.4 and a dividend yield of 2.7 indicate an attractive valuation per that article. Cisco also holds $40.4 billion in cash, about $9 per share, versus debt of $25.6 billion. More important still, its massive installed base of equipment, its technical innovation, and its shift to a subscription-based pricing model provide a competitive moat in a fast-growing market, The Fool adds.
While fast-growing ROE is a logical consideration in selecting stocks, no screening method guarantees future outperformance, certainly not over a short time period. For example, among the recently underperforming stocks in Goldman's basket are travel booking service TripAdvisor Inc. (TRIP), up 4.6% YTD, and biotech firm Amgen Inc. (AMGN), down 3.2% YTD.
Moreover, Goldman filled its basket based on forecasted earnings and ROE, which may not materialize as expected. Also, one can debate whether ROE itself, rather than the projected growth in ROE, makes more sense as a selection criterion. Among the 50 stocks in the basket, 24 have a forward ROE below the S&P 500 median of 19%, with 7 of them in the single digits. Lastly, a better measure of ROE arguably uses the market price of equity rather than book value.