As the economy reaches the later stages of its cycle and profit growth slows, investors should take a look at Goldman Sachs’ basket of more than 30 Russell 1000 stocks with high gross profit margins that have proven stable over time. Seven of those stocks, which have been recent outperformers, include Verisign Inc. (VRSN), Amgen Inc. (AMGN), Cadence Design Systems Inc. (CDNS), Adobe Systems Inc. (ADBE), IDEXX Laboratories Inc. (IDXX), Liberty Media Corp. (LSXMA) and O’Reilly Automotive Inc. (ORLY). “Investors should focus on stocks with high and stable gross margins,” wrote the bank’s analysts. This is the second of two stories that Investopedia has devoted to this topic.

Stock/Index  Total Return YTD (as of July 11)
 IDEXX  49.7%
 Adobe  41.6%
 Verisign  26.5%
 Liberty Media  18.1%
 O'Reilly Automotive  17.8%
 Amgen  12.7%
 Cadence Design   6.7%
 S&P 500  5.5%

Input costs in the form of commodity prices, short- and long-term interest rates, and U.S. wage growth are on the rise, and that means net profit margins are getting pinched. Oil, a key commodity input, is now up above $75 per barrel versus around $45 just two years ago. The Fed funds target interest rate is currently around 1.9% versus near 0% at the end of 2016, and 10-year Treasury yields are up nearly 0.8% from their level in mid- to late-2017, pushing up both short- and long-term borrowing costs. Core PCE inflation, now running close to the Fed’s 2.0% target, and relatively low initial jobless claims indicate an improved U.S. labor market putting upward pressure on wages.

Considering these cost pressures and the tailwind boost from lower corporate tax rates expected to fade in the latter half of the year, Goldman’s analysts argues that stocks with high and stable gross margins tend to outperform in such environments. “We expect the trade will continue to outperform as the margin tailwind from tax reform passes,” wrote the analysts. 

Fast Growth at Adobe and Amgen

As the go-to company for the software solutions that it provides, Adobe is expected to exhibit above average growth. Consensus forecasts put the company’s sales growth for the year at a strong 22.40% and earnings growth at an impressive 56.10%, with annual expected earnings growth of 23.83% over the next five years. (To read more, see: Adobe’s Stock Seen Rising on Robust Profit Growth.)

Sales of Amgen’s heart drug Repatha finally showed signs of gaining traction following last quarter’s earnings report, and investors are now concentrating on whether the biotech company’s CGRP migraine therapy drug will be approved. On that front, the options market indicates that investors are becoming increasingly bullish on the stock.

 

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