US corporate profit growth is in lofty territory thanks to President Donald Trump‘s tax overhaul.
Digging a bit further under the surface, margins look even stronger. They’re at record highs.
Enjoy the high-margin heyday while it lasts, says Goldman Sachs, because this is as good as it’s going to get.
For one, margins are so high that they have nowhere to go but down. But Goldman has also identified another culprit: Trump’s burgeoning trade war with China.
“Tariffs threaten corporate earnings through higher costs and lower margins,” David Kostin, Goldman’s chief US equity strategist, wrote in a client note.
One of Goldman’s downside scenarios for the trade war is particularly stark. The firm estimates that if 25% tariffs on all US imports from China take hold, S&P 500 earnings growth for 2019 will be flat on a year-over-year basis.
Even Goldman’s most optimistic outlook — which calls for 7% earnings growth — is still down more than 10 percentage points from its full-year 2018 forecast. Neither outcome is what investors want to see with stocks already looking fully priced.
So how is an investor to outperform the market going forward? Goldman recommends finding and investing in the companies most likely to keep profit margins growing.
“As the boost from tax reform fades, firms with the ability to maintain or expand profit margins will become increasingly scarce and will likely be rewarded by investors,” Kostin said. “Companies with high pricing power are well-positioned to pass through input cost pressure to consumers, preserving high margins.”
This is, of course, easier said than done. But Goldman is here to help. The firm maintains a list of companies notable for their recent margin strength.
Goldman calculates a measure of gross margin variability, which divides the standard deviation of the past five years of gross margins by its average level over the period.
It then applies this to the Russell 1000 and finds the stocks that: (1) are in the top quintile of their sector based on the level and stability of gross margins over the past five years and (2) have experienced steady or expanding gross margins during the past two years.
Without further ado, here are the 14 stocks with the lowest coefficient of variation in gross margins — meaning they’re best equipped to withstand further trade-war pressures.
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