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Conventional wisdom says the market's record rally this year is likely feeding demand for companies with risky balance sheets. That wisdom is wrong, says Goldman Sachs.
Corporate America has ramped up its cash spending thanks to the corporate tax cut, but the spending isn't making these riskier companies more appealing to investors. In fact, they still prefer those with strong balance sheets, said Goldman's chief U.S. equity strategist David Kostin.
"Firms boosted total cash spending by 25% to $2.8 trillion in 2018. However, investors have not rewarded most forms of cash spending during the past 12 months," said Kostin in a note Friday. "Recent market performance indicates a clear investor preference for safe, high quality balance sheets rather than firms investing for growth, returning cash to shareholders, or paying down debt."
Goldman created a strong balance sheet basket with 50 companies in the S&P 500 that screens high for working capital to assets, retained earnings to assets, operating income to assets, leverage ratio and sales to assets. The basket has outperformed a similar basket of weak balance sheet stocks by 15 percentage points since 2018.
The portfolio also scored a 22% return year to date, beating the S&P 500's 17% gain and the weak balance sheet basket's 20% return.
The constituents include Facebook, Chipotle Mexican Grill, Monster Beverage and Nvidia. Facebook has been a front-runner this year among the so-called FANG names with a whopping 48% year-to-date gain. Chipotle is the biggest winner in the market rebound, skyrocketing 82% from December's sell off as the company crushed Wall Street expectations with its earnings and turnaround plan.
"After two years of steady outperformance, strong balance sheets now trade at an 83% Price to Earnings multiple premium (a 94th percentile reading since 1980) to weak balance sheets," Kostin said.
Goldman's other portfolios related to company cash spending, including buyback basket, dividend growth basket and total cash return to shareholders, are all merely matching the S&P 500's return this year.