While growth stocks have shown "extraordinary performance" since the start of 2017, Goldman Sachs Group Inc. (GS) advises investors to stick with this segment of the market, rather than switch to value stocks. "Steady economic activity and a gradually tightening Fed create an environment conducive to further growth stock outperformance," per their latest U.S. Weekly Kickstart report, dated March 16.
They identify 50 stocks in the S&P 500 Index (SPX) that show "the fastest growth in their sectors based on realized and consensus forward earnings and sales growth," including these 12: Visa Inc. (V), MasterCard Inc. (MA), PayPal Holdings Inc. (PYPL), Amazon.com Inc. (AMZN), Costco Wholesale Corp. (COST), Concho Resources (CXO), Nvidia Corp. (NVDA), Align Technology Inc. (ALGN), Vertex Pharmaceuticals Inc. (VRTX), Charles Schwab Corp. (SCHW), Salesforce.com Inc. (CRM) and Monster Beverage Corp. (MNST).
Goldman's Case for Growth
Looking at monthly data since 1980, Goldman finds that "Contrary to popular intuition, Growth outperformance has not historically signaled subsequent value outperformance." They forecast U.S. GDP growth at 2.6% in 2018 and 2.2% in 2019. "In environments of healthy but modest economic growth, investors typically allocate a scarcity premium to firms able to generate superior growth," they say. Moreover, they find that growth stocks outperform when the Fed tightens, flattening the yield curve, and economic growth slows. (For more, see also: 5 Characteristics of Good Growth Stocks.)
Goldman also notes that value stocks are poised for outperformance when there is wide dispersion among P/E ratios in the S&P 500, giving investors ample opportunities to buy stocks with low valuations and sell those with high valuations. However, right now dispersion is below average in all sectors except health care, Goldman finds.
Moreover, somewhat paradoxically, Goldman observes that, despite having high valuation multiples, some high multiple growth stocks actually offer superior value to investors. Relative to history, they say, "some of the most expensive and fastest-growth S&P 500 firms also carry the least elevated multiples relative to history. For example, Goldman says, stocks with long-term growth estimates in the range of 20% to 30% have a median forward P/E of 22 times earnings, higher than 58% of the readings for this group taken since 1985. They contrast that with the median S&P 500 stock, which they say has a forward P/E that is greater than 90% of its historic values. (For more, see also: Top 3 Growth Stocks for 2018.)
Applying PEG Analysis
Goldman's group of 50 high growth rate stocks has a median forward P/E of 24 times earnings, versus 17 for the full S&P 500. They also have a median long-term EPS growth rate of 20%, compared to 11% for the S&P 500. Based on PEG ratio analysis, which compares valuation multiples to growth rates, the 50 growth stocks have a lower median PEG valuation (24/20 = 1.2) than the S&P 500 (17/11 = 1.5).
Among the stocks on Goldman's list, discount brokerage firm Charles Schwab stands out for long-term earnings growth that is above the group's median, at 27%, and a forward P/E that is below the group's median, at 23. Looking at long-term earnings growth, oil and gas company Concho Resources, at 64%, and Vertex Pharmaceuticals, at 69%, are among the top four on the list. Along with these spectacular growth rates come very high valuations, with respective forward P/Es of 42 and 59. Still, all three of these stocks have PEG values below 1.0, which normally is taken as a sign of attractive valuation.
At the other extreme is Amazon.com, which has a forward P/E of 178 and a growth rate of 31%, per Goldman, for a lofty PEG ratio of 5.7, the highest among the 50 stocks. Payments processors Visa and MasterCard are closer to the median for the 50, at PEG ratios of 1.4 (P/E 27 and 19% growth) and 1.5 (P/E 30 and 20% growth), respectively.