Goldman says own these frugal stocks with corporate profitability under siege

Published Mon, Sep 19 20223:04 PM EDT

Corporate profits will continue to be crushed amid high inflation and Federal Reserv e interest rate hikes, according to Goldman Sachs. Yet some stocks are better positioned than others to navigate the headwinds, the investment bank said. Goldman expects S & P 500 net profit margins to fall by 25 basis points in 2023, weighing on the index's return on equity, or ROE. Already this year, profitability has weakened, with the S & P's ROE declining by 84 basis points in the second quarter. ROE, a widely used metric to gauge the profitability of a company, is the measure of a company's net income divided by its shareholders' equity. Margins are the primary downside risk, while rising interest rates and higher tax rates are also in play. "In the face of inflation, rising interest rates, and more Fed tightening, equity valuations likely face further downside," Goldman chief U.S. equity strategist David Kostin wrote in a note out on Friday. "From a fundamental perspective, firm inflation also increases the risks facing profit margins." "Pressure on profitability and tightening financial conditions support owning stocks with high returns on capital, which trade at a lower valuation premium than other 'quality' factors such as strong balance sheets and low volatility," he added. With that in mind, Goldman rebalanced its "ROE Growth" basket, which contains 50 stocks with the highest consensus expected ROE growth during the next 12 months. The median stock is expected to grow ROE by 14% during that time, compared to a loss of 5% for the median S & P 500 company, Kostin said. He added 21 new companies to the basket. Charter Communications , Amazon and Nike were among those added to the basket, all with expected ROE growth close to 40%. Charter Communications, whose second-quarter earnings beat expectations, has seen its stock particularly hard hit this year. It is down about 44% year to date. The sector with the highest growth is real estate. Real estate investment trusts UDR , which owns, develops and operates multifamily apartment communities, and Host Hotels & Resort are new to the basket. UDR is expected to grow ROE by 49%, while Host Hotels & Resort should see 47% growth. UDR, which is down almost 27% so far this year, recently reported market rents continued to increase sequentially in August. "This along with our innovation and differentiated approach to pricing homes, continues to drive strong growth," the company wrote in a September investor presentation . Among the financial names new to the basket is Allstate , with an expected ROE growth of 28%. The insurer is up 11% despite its second-quarter earnings-per-share missing Wall Street estimates. Revenue, however, came in above expectations. — CNBC's Michael Bloom contributed reporting.