The stock market rally in January has delivered strong gains, but an unusually large number of portfolios created by Goldman Sachs have done much better. Among their 31 thematic strategy baskets drawn from stocks in the S&P 500 Index (SPX), 90% of them have beaten the index, and 17 (55%) have outperformed by 50% or more, based on analysis of total returns, including dividends, this year through Jan. 25.
This story, the second of two articles, looks at five portfolios, all of which beat the S&P 500 by at least 50%, as detailed in the table below. The portfolios are named: ROE Growth, Strong Balance Sheet, High Adjusted FCF Yield, Low Tax, and Low Labor Cost. In our first article on Wednesday, we looked at three other Goldman portfolios.
5 Portfolios With Shining Returns
(YTD Total Returns)
- ROE Growth: +10%
- Strong Balance Sheet: +10%
- High Adjusted FCF Yield: +9%
- Low Tax: +9%
- Low Labor Cost: +9%
- S&P 500: +6%
Source: Goldman Sachs; as of 1/25
Significance For Investors
Below are closer looks at the two of these baskets, ROE Growth and High Adjusted Free Cash Flow Yield. The Federal Reserve's new stance that it will pause in raising interest rates should be a positive for most of Goldman's baskets. Regarding the Strong Balance Sheet portfolio, the pause may reduce some of its potential for outperformance versus highly leveraged, weak balance sheet stocks.
ROE Growth Portfolio. This basket, which posted 10% growth this year, contains 50 stocks in the S&P 500 with the best projected growth rates in return on equity (ROE) based on forecasts of earnings and book value. Their methodology is the result of a 30-year study that also applies various filters.
The median stock in the basket is projected to increase its ROE by 23% from the last 12 months to the next 12 months. By contrast, the median S&P 500 stock is expected to deliver an increase of only 3%. Among the stocks in this basket are Cisco Systems Inc. (CSCO), a leading provider of computer networking products and services, biotech company Amgen Inc. (AMGN), and railroad Union Pacific Corp. (UNP).
These stocks have projected ROE growth rates ranging from 35% to 46%, and forward ROEs that are roughly two or three times greater than the S&P 500 median. Amgen this week reported fourth quarter earnings that beat the consensus estimate by 4.9%, per Zacks Equity Research. Last week, Union Pacific delivered an earnings surprise of 2.9%, per Zacks.
High Adjusted Free Cash Flow Yield Portfolio. Goldman's analysts say the industry's traditional approach of dividing free cash flow by market capitalization has some major weaknesses. "Traditional FCF yield does not differentiate between high cash flow from operations and low capital expenditures...making it difficult to compare across sectors or between companies with different types of balance sheets," Goldman says. Their adjustment adds back total capital expenditures minus depreciation and R&D spending.
Goldman's FCF portfolio posted a 9% return thus far this year. The median stock in this basket of 50 companies has an adjusted free cash flow (FCF) yield of 14%, versus 6% for the median S&P 500 stock. Among the stocks with the highest FCF yields in the basket are semiconductor maker Micron Technology Inc. (MU), at 42%, vehicle manufacturer Ford Motor Co. (F), at 36%, and DISH Network Corp. (DISH), a provider of TV programming via satellite and the internet, at 28%.
Several of Goldman's baskets are designed to defend against a slowing economy or bear market. If the Fed follows through and pauses its interest rate hikes as announced, this may have a dramatic impact on the returns of many of these portfolios in 2019. In that case, the riskier portfolios would be much better positioned to outperform.