Goldman's 'Rule of 10' growth stocks could be the next market leaders

Published Thu, Sep 17 20207:04 AM EDT

(This story is for CNBC Pro subscribers only.) The five biggest stocks — Apple , Microsoft , Amazon, Alphabet , and Facebook — currently account for 23% of the S & P 500 , marking the highest concentration in 40 years. But Goldman Sachs said their leadership won't last forever and other high-growth stocks have the potential to one day take some of those top spots. Goldman used the so-called "Rule of 10" criteria to identify stocks with strong secular growth prospects that could drive share price outperformance. These stocks, according to the firm's investing rule, have a track record of at least 10% sales growth during each of the past two years and they are expected to grow revenue at the same pace for each of the next two years. Stocks meeting these criteria have a strong track record of beating the market, the bank said. "Index leadership is difficult to maintain," David Kostin, head of U.S. equity strategy at Goldman, said in a note. "The list of companies comprising the top positions in indices is not immutable." For example, in 2000, the five largest stocks by market cap accounted for 18% of the S & P 500 but today those same companies comprise just 8% of the index, according to Goldman. In contrast, 20 years ago the current five market leaders represented just 3% of the S & P 500. Additionally, only one of the five largest stocks in 2000 remains on the current list, which is Microsoft, while Facebook, the fifth-largest stock now was not even a member of the index until eight years ago, the bank added. Using the "Rule of 10" method, Goldman found 21 companies in the S & P 500 with the potential to be future index leaders. The median stock in the group is expected to expand sales growth by 18% from 2018 to 2022, versus 4% for the median S & P 500 stock. The median return has come to 21% so far this year, Goldman said. "These stocks will not necessarily supplant the current five largest companies. But they have the potential to significantly increase their rankings and in the process generate strong returns for portfolio managers owning the shares," Kostin said. The majority of these names also fit into five high-growth trends that Goldman identified — computerization of healthcare; digital transformation of business; workflow automation; ecommerce and digital payments and advancements in life sciences. Goldman highlighted a slew of healthcare stocks that are experiencing superior growth, including Abiomed, Align Techonology , Edwards Lifesciences , Intuitive Surgical and Vertex Pharmaceuticals . The health care sector enjoyed a tailwind this year as investors piled into the industry on optimism about a breakthrough of a coronavirus treatment and vaccine. Many software companies are well-positioned to benefit from the ongoing digital transformation of businesses amid the pandemic. Autodesk , Adobe, Salesforce and ServiceNow have been some of the most popular working-from-home bets this year. Adobe got a boost this week after reporting better-than-expected earnings and revenue for the fiscal third quarter. The stock is up more than 46%. Meanwhile, Goldman picked MasterCard and PayPal as potential winners in the digital payments space. PayPal, the parent of an e-commerce portfolio that includes Venmo, Honeywell and Braintree, saw its revenue surge 22% last quarter in the middle of a coronavirus pandemic that pushed the U.S. economy into a perilous position. Shares of PayPal are up more than 68% this year. "As a digital payments leader, PayPal is well-positioned to benefit from the shift in spending online in nearly every category and away from cash in the physical world, particularly through the acceleration in the growth of e-commerce globally," Goldman said. Other "Rule of 10" stocks include Netflix , Twitter, Monster Beverage, and Fortinet .

Pedestrians pass in front of the Salesforce Tower in New York.

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(This story is for CNBC Pro subscribers only.)

The five biggest stocks — Apple, Microsoft, Amazon, Alphabet, and Facebook — currently account for 23% of the S&P 500, marking the highest concentration in 40 years. But Goldman Sachs said their leadership won't last forever and other high-growth stocks have the potential to one day take some of those top spots.

Goldman used the so-called "Rule of 10" criteria to identify stocks with strong secular growth prospects that could drive share price outperformance. These stocks, according to the firm's investing rule, have a track record of at least 10% sales growth during each of the past two years and they are expected to grow revenue at the same pace for each of the next two years. Stocks meeting these criteria have a strong track record of beating the market, the bank said.