Companies are set to become even more profitable this year as they benefit from a lower corporate tax rate, according to Goldman Sachs' chief U.S. equity strategist.
In a note to clients sent Friday, David Kostin said he expects the S&P 500's return on equity to rise to 17.6 percent for 2018, its highest since 2007. Return on equity, often abbreviated as "ROE," is a measure of profitability that is calculated by dividing net income by shareholders' equity. It is also expressed as a percentage. Last year, the S&P 500's ROE expanded by 180 basis points to 16.3 percent.
"The reduction in the corporate tax rate alone will boost ROE by roughly 70 [basis points], outweighing margin pressures from rising labor, commodity, and borrow costs," Kostin wrote. He also said the consumer discretionary and telecommunication sectors will benefit the most from tax reform "given their previously high effective tax rates."
President Donald Trump signed a bill in late December that slashed the corporate tax rate to 21 percent from 35 percent. Investors had been anticipating a lower rate heading into 2018 and thus pushed stocks to record levels last year.
Stocks, however, have been under pressure lately amid concerns that a trade war could be brewing between the U.S. and China, something that could raise costs for U.S. companies and hurt profits. Last week, the major U.S. stock averages posted their biggest weekly drop since January 2016.
But Kostin said investors should not worry too much about this. "Despite market anxiety about trade conflict, S&P 500 profitability remains very healthy," he said.
The lower corporate tax rate and the expected rise in return on equity led Kostin to rebalance the Goldman ROE Growth basket, which is made up of 50 S&P 500 stocks the investment bank expects to have the fastest ROE growth over the next year.
Kostin said the basket has 30 new additions, including Metlife, MGM Resorts and Bristol-Myers Squibb. Goldman sees Metlife's ROE growing by 43 percent over the next 12 months, while MGM and Bristol-Myers should increase by 37 and 13 percent, respectively.