As the nine-year bull market has come to an end, investors have been rattled by giant swings in the market, sending some of Wall Street's favorite stock picks into correction territory. Investors looking to minimize losses amid the sell-off and instead focus on the longer-term horizon may want to consider a list of stocks with superior return on equity (ROE) growth, a measurement of corporate profitability calculated by taking net income as a percentage of shareholder equity.
Analysts at Goldman Sachs have compiled a group of stocks with high ROE that they indicate are positioned to continue to outperform the broader market as they remain beneficiaries of the recently passed GOP tax cuts and successfully minimize rising costs. Last week, Investopedia told readers about nine of 50 stocks in Goldman's ROE growth basket, expected to have the fastest ROE growth during the next 12 months. This week, we add MGM Resorts International (MGM), Best Buy Co. Inc. (BBY), The Coca-Cola Co. (KO), Bank of America Corp. (BAC), Vertex Pharmaceuticals Inc. (VRTX), Oracle Corp. (ORCL) and Salesforce.com Inc. (CRM) to the group. (See also: 9 High-Return Stocks for a Shaky Market.)
The equal weighted and sector-neutral basket's median constituent is forecasted to grow its ROE by 5%, from 23% to 28%, versus a 1% decline for the median S&P 500 stock under Goldman coverage. The median stock in the list trades at a price-to-book multiple of 5.7, compared to 3.5 times for the median stock in the S&P 500.
For the seven new stocks cited, their forward ROEs and ROE growth rates are:
- MGM Resorts: 11%, 37%
- Best Buy Inc.: 42%, 25%
- Coca-Cola: 52%, 20%
- Bank of America: 10%, 38%
- Vertex Pharmaceuticals: 23%, 22%
- Oracle: 28%, 13%
- Salesforce: 16%, 29%
Goldman's report was published on March 23, when the S&P 500 was at about the same level it is today. At $2,644.69 as of Wednesday close, the S&P 500 reflects an approximate 1.1% decline year-to-date (YTD) and a 12.1% increase over the most recent 12 months.
S&P 500 Maintains Profitability
Investor fears regarding an impending global trade war have dragged down the broader market, particularly shares of companies with large international businesses such as jet maker Boeing Co. (BA). Yet despite recent market anxiety about increasingly protectionist policies from the White House, analysts at Goldman note that S&P 500 profitability remains "very healthy." ROE jumped by 180 basis points in 2017 to 16.3%. Excluding financials, profitability rose to 19.4%, marking its highest level in at least five years, driven by lower taxes and higher margins.
In 2018, Goldman foresees ROE jumping to 17.6% as American corporations save billions on Trump tax cuts to help offset slowing margin expansion and rising borrow costs. A 70 basis point increase in ROE attributed to a lower statutory tax rate at 21% this year should most benefit companies in the consumer discretionary and telecom services segments, given their previously high effective tax rates. As rising wages and commodity prices are expected lead to lower pre-tax profit margins, the investment bank recommends investors avoid firms with high labor costs relative to revenue, as consumer discretionary and health care stocks are set to fare the worst. (See also: Stocks Post Worst Q1 Since Great Depression.)