High-margin stocks with 'pricing power' in their markets are well positioned for more gains ahead, according to Goldman Sachs. This group of 50 stocks has posted stunning performance in the past year compared to low-margin stocks, and may outperform in the upcoming period as rising costs continue to pressure U.S. corporations, says Goldman in its latest US Thematic Views report. "Growing margin pressures have driven the outperformance of stocks with high pricing power," the firm says. "Our screen of stocks with high and stable gross margins has outperformed low pricing power stocks by 20 percentage points during the past year."
The firm said in its March 15 report that the Fed's dovish policy eventually could lead to faster increases in inflation that could further benefit these high-margin stocks. In its policy statement today, the Fed said it expected 2% inflation in main and core indexes over the next 2 years, in line with its targets.
Goldman's screen of 50 stocks with high pricing power includes 6 that we focus on in this story: Autodesk Inc. (ADSK), VF Corp. (VFC), Rockwell Automation Inc. (ROK), NetApp Inc. (NTAP), Capri Holdings Limited (CPRI), and Edwards LifeSciences Corp. (EW). This is the first of two articles on Goldman's report, and second will be appear Thursday morning.
In addition to extremely high average gross margins, these stocks are expected to post significant margin growth over the next year even as the economy slows. (see table below).
6 Stocks With Pricing Power
(5-year average gross profit margin)
Source: Goldman Sachs
Goldman expects the outperformance of high-margin stocks to extend and intensify into the upcoming period, per the report. The list of high pricing power stocks has beaten the list of low pricing power stocks by 17 percentage points (+13% vs. -4%) since May 2018. Most of the high-margin stocks in Goldman's group are in Info Tech, Consumer Discretionary, and Healthcare.
Most important, Goldman expects these stocks to boost their margins even as most companies struggle to pass through rising input costs. Analysts note that consensus estimates call for a 40 basis point decline in S&P 500 profit margins during 2019 from their record high in 2018.
Goldman added that stocks with low labor costs should also outperform in an environment of rising inflation. High labor costs are a primary concern of companies today. A larger percentage of companies cited labor costs as their single most important problem than in any other month since 1973, according to a recent NFIB small business survey.
Computer-aided design company Autodesk illustrates this group's strength. The company has posted an average 84% gross profit margin over the past 5 years, more than double the average for the Russell 1000, and it ranks no. 5 in estimated margin growth this year in Goldman's 50-stock basket. Autodesk's shares have gained 19.2% year-to-date (YTD) and 13.2% over 12 months compared to the S&P 500’s 12.3% and 3.8% increases over the same respective periods. Last month, Autodesk beat estimates for its fiscal fourth quarter.
Despite the positive outlook for this group, their attractiveness could suffer if inflation accelerates too quickly or if they become overwhelmed by a sharp contraction in the economy.