Despite the market trading near record highs, Goldman Sachs says that a select group of reasonably priced, high-ROE growth stocks will lead the market in the coming months. These include: Netflix Inc. (NFLX), which has an expected ROE growth in the next 12 months of 17%, Procter & Gamble (PG) 8%, American International Group (AIG) 17%, Eli Lilly & Co. (LLY) 19%, Oracle Corp. (ORCL) 22%, Union Pacific Corp. (UNP) 20%, Fidelity National Info Svc. (FIS) 27%, Chipotle Mexican Grill Inc. (CMG) 19%, and Broadcom Ltd. (AVGO) 12%.
This is the second of two articles in which Investopedia takes a look at Goldman's high ROE picks.
Weak Backdrop for Aggregate ROE
“Given the weak backdrop for aggregate ROE, investors should focus on our ROE growth basket, " wrote Goldman analysts in the firm’s most recent U.S. Weekly Kickstart report dated Sept 20. "While stocks with low volatility and strong balance sheets still trade more than 2 standard deviations expensive relative to the past 10 years, stocks with high returns on capital carry more reasonable valuations." Goldman adds, "We expect investors will continue to assign a valuation premium to stocks with high returns given S&P 500 ROE declined modestly in the 2Q to 18.8% and the outlook for ROE is challenging."
Goldman indicated that the average stock in its sector-neutral basket trades at a “modest valuation discount” to the broader market. The basket of 50 stocks had outperformed the S&P 500 as of the report’s publishing on Friday, higher 24% compared to a 22% return for the broader index. The average stock in the basket is forecasted to grow ROE by 12% during the next 12 months as the S&P median stock sees ROE decline by 1%, per Goldman. Analysts expect the basket’s outperformance to continue as headwinds such as higher input costs, wages, excess inventory and weaker pricing weigh on many companies’ profit margins.
Shares of railroad company Union Pacific have returned over 20% YTD through Monday close. Many investors view the stock as a bond-like investment due to the stability of its market positioning. While the industry does face competition in a disrupted transportation space, with the growth of trucking and other methods of travel, the largest railroad stocks tend to have a stronghold in their respective territories.
In July, Union Pacific stock jumped on better than expected second quarter earnings as investors were assured by a greater portion of consumer-oriented revenues. Margin improvement is also a factor seen as driving railroad stocks higher, as outlined by Barron’s.
Goldman’s report included its recently reconstructed Sentiment Indicator (SI), which was in “stretched” territory, suggesting near-term headwinds to the S&P 500. However, their year-end price target of 3100 “implies the current forward P/E of 17.5x remains stable.”