Goldman says bet on these stocks with expanding profitability into earnings season

Published Mon, Jul 12 202110:35 AM EDT

As the second-quarter earnings season kicks off, Goldman Sachs says investors should focus on companies that have been able to defend profits by raising prices and passing higher costs to customers. On the surface, this is slated to be a stellar earnings season with profits for S & P 500 companies expected to jump 65% from the same quarter a year ago in the depths of the pandemic, according to Refinitiv. However, Goldman noted that the median stock is only forecast to grow earnings by 24%, and many companies are expected to feel the pain from higher inflation. "Global shipping woes, raw material inflation as well as acute shortages in both labor and semiconductors have combined to increase costs for companies across the economy," David Kostin, Goldman's head of U.S. equity strategy, said in a note. The S & P 500 has climbed to multiple records with a 16% rally in 2021, shaking off fears that the economic recovery might be slowing down and that the Federal Reserve might start tightening ultra-easy monetary policy. Many on Wall Street believe the second half of the year will be much choppier and investors should take a more selective approach. In this inflationary environment, companies with the highest profit margins have started to outperform, according to Goldman. "Investors have started to reward companies with attractive margin profiles," Kostin said. "Our valuation model shows than profit margins are the second most important driver of company valuations today, behind only equity duration." To identify stocks with expanding profitability, Goldman screened S & P 500 companies with above-average net margins, realized margin growth of 50 basis points or more in 2020, and expected margin growth of 50 basis points for more in each of the next two years. The median stock in the basket has a net margin of 26% in 2021, versus 13% for a typical S & P 500 stock. Meanwhile, the median stock in the screen is also expected to grow margins by 306 basis points through 2022, compared to 156 basis points for the median S & P 500 stock. The list features a slew of semiconductor companies including Texas Instruments , Broadcom , Analog Devices and Microchip Technology . Many chip companies are benefiting from surging demand among smartphone makers, auto companies and gaming firms amid a global shortage. Mining companies Newmont Corp. and Freeport-McMoRan were also highlighted by Goldman, as well as railroad company Union Pacific .

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Source: NYSE

As the second-quarter earnings season kicks off, Goldman Sachs says investors should focus on companies that have been able to defend profits by raising prices and passing higher costs to customers.