Goldman Sachs says that stocks with low ratios of labor cost to sales are well-positioned to lead the market as the lowest unemployment rate in 50 years pushes wages up and profit margins down. "Although large caps are less exposed than small caps to wage pressures, rising wages will be a differentiating factor on a relative basis within the S&P 500," Goldman says. "In the near term, we recommend stocks with low labor costs, which are relatively insulated from wage pressures," they add.
Among the 50 stocks in Goldman's Low Labor Cost basket are these eight: media company ViacomCBS Inc. (VIAC), device and applications provider Apple Inc. (AAPL), insurer Everest Re Group (RE), apparel maker Under Armour Inc. (UAA), energy producer Cabot Oil & Gas Corp. (COG), medical supplies company AmerisourceBergen Corp. (ABC), labels and adhesives maker Avery Dennison Corp. (AVY), and electric utility Pinnacle West Capital Corp. (PNW).
- Goldman Sachs recommends stock wth low labor costs.
- The ratio of labor costs to sales is their key metric.
- S&P 500 firms have much higher profit margins than smaller firms.
Significance For Investors
A growing number of respondents to a survey from the National Association for Business Economics (NABE) have been reporting rising wages since 2013. Despite that, "S&P 500 profit margins have risen sharply and are just off all-time highs at 11%," Goldman writes.
But other figures show a more ominous trend. "Profit data based on the National Income and Product Accounts (NIPA) show a different picture with margins declining to 6% in recent years," Goldman notes, referencing U.S. federal government data for the entire economy. However, aggregate S&P 500 profits are just 61% of the NIPA total, which also includes much smaller, less efficient, and less profitable companies. As a result, Goldman says that fears about S&P 500 profit margins dropping towards the NIPA number are overblown.
About their basket, Goldman states: "Our 50-stock, sector-neutral, low labor cost basket (GSTHLLAB) contains firms with the lowest labor costs as a share of sales. The metric is based on the number of employees at a given firm and each company’s median employee compensation disclosed in proxy filings. The median stock in the basket has labor costs that equal just 5% of revenues, offers similar sales and EPS growth as the S&P 500, and trades at a discount to the S&P 500 (14x vs. 18x)."
The labor cost to revenue ratios for the eight highlighted stocks stocks are: Pinnacle West at 0%, Amerisource Bergen and Cabot at 1%, ViacomCBS at 2%, and Under Armour, Apple, Everest Re at 3%, and Avery Dennison at 5%.
According to consensus estimates, the median stock in the basket is projected to increase EPS by 7% in 2020, compared to 8% for the median S&P 500 stock. For the eight selected stocks, the figures are: Under Armour, 41%, ViacomCBS, 17%, Apple, 11%, Avery Dennison, 8%, Amerisource Bergen, 6%, Pinnacle West, 4%, Everest Re, 3%, and Cabot, -24%.
Goldman believes that rising labor costs, overall, are manageable for the S&P 500. Labor costs are just 12% of revenues for the S&P 500, yet in the U.S. economy as a whole they are 27% of gross output. The size and efficiency of the S&P 500 companies are partly the reason for this disparity. Also, large companies often have the bargaining and pricing power to reduce the negative impact on their profit margins.