Given mounting economic and stock market uncertainties in 2019, Goldman Sachs is advising investors to look for stocks that offer a margin of safety. "The low starting valuation of the S&P 500 suggests a positive skew to the distribution of our forecast S&P 500 returns in 2019," says Goldman's latest U.S. Weekly Kickstart report, which finds that the forward P/E ratio for the index has fallen toward historical averages during the past year, as detailed in a prior Investopedia article.
Here are eight stocks in Goldman's "margin of safety" basket, in addition to the eight presented in our first article: Colgate-Palmolive Co. (CL), Kroger Co. (KR), Sysco Corp. (SYY), PPG Industries Inc. (PPG), Illinois Tool Works Inc. (ITW), AvalonBay Communities Inc. (AVB), Citrix Systems Inc. (CTXS), and Tyson Foods Inc. (TSN). The table below offers a quick summary of Goldman's screening steps, which were explained in more detail by our previous article.
How Goldman Selected Its Margin of Safety Stocks
- Adjusted forward P/E less than 10% above 10-year historic median
- Strong balance sheet
- Pays a dividend
- Low beta, below the S&P 500 median
- Low ownership by hedge funds
Source: Goldman Sachs
Significance For Investors
What Goldman calls the adjusted forward P/E was calculated by reducing the consensus estimate of EPS over the next 12 months by 10%. This attempts to correct for the possibility that forward valuations may be understated, if based on earnings estimates that are too optimistic. "This measure is particularly relevant in light of AAPL’s [Apple Inc.'s] negative preannouncement on Wednesday [Jan. 2] amid the slowdown in China’s economy," Goldman's report stated.
Meanwhile, Goldman observes that a flight to "quality" has been underway among investors. Low volatility (which is related to beta) and strong balance sheets are among the "quality" factors that have "outperformed [in 2018] as investors assigned a premium to defensive characteristics," the report found.
As with the eight stocks mentioned in our previous article, the eight additional equities listed above span a variety of industries: food and other consumer staples (Tyson, Sysco, Kroger, and Colgate-Palmolive), information technology (Citrix), industrials (Illinois Tools), materials (PG), and residential real estate (AvalonBay).
Kroger, based in Cincinnati, is the largest U.S. grocery chain in terms of stores and revenue. Kroger beat analysts' estimates for the fiscal quarter ending in November, the third quarter of its current fiscal year. However, while reporting that same store sales increased by 1.6% year-over-year (YOY), total sales and earnings were down, per MarketWatch. To keep pace in an increasingly tough competitive environment, Kroger has reduced prices both in-store and online, the same article notes.
"We're moving from a traditional grocer to a growth company," per a statement from CEO Rodney McMullen, as quoted by MarketWatch. To that end, Kroger is forging alliances to increase both in-store and online sales. For example, there now are Kroger-branded sections in select Walgreens Boots Alliance Inc. (WBA) drug stores. Meanwhile, Kroger stores are selling clothing and other non-food merchandise to compete with Walmart Inc. (WMT), and the company has a deal with the owners of the defunct Toys "R" Us brand to sell branded toys and other goods. Kroger also has a stake in U.K.-based online grocer Ocado Group PLC.
"Strategically, we recommend investors increase portfolio defensiveness," Goldman also advises. "With 3-month US T-Bills at 2.4% and de minimis [i.e., minimal] volatility, cash now represents a competitive asset," they add.
Regarding the "margin of safety" stocks listed above, a decline in overall economic growth will be a negative for them all. Moreover, should the stock market continue to decline, even in the absence of a recession, low beta stocks are still prone to fall, though to a lesser degree than the market as a whole. Regarding Kroger, it remains to be seen whether the initiatives discussed above will bear fruit, and reverse its declining prospects.