Being a successful investor this coming earnings season may be as easy as paying attention to companies with the best potential to expand profit margins amidst the current bout of inflation across spectrums such as raw materials and labor, Goldman Sachs reasons.
The smartest investors in the game appear to already be placing that bet.
"Investors have started to reward companies with attractive margin profiles. Our valuation model shows that profit margins are the second most important driver of company valuations today, behind only equity duration," said David Kostin, Goldman Sachs chief U.S. equity strategist, in a new research note to clients.
Kostin outlined 32 companies spanning the health care, industrial, materials, staples and information technologies sectors that have above average net profit margins and are likely to expand them further in 2021 (see below). The median return on these stocks year-to-date has tallied 14%.
Some of the top-performing stocks include Old Dominion Freight Line, NortonLifeLock, Applied Materials, Seagate Technologies and Freeport-McMoran. All of these names are seen increasing their earnings in excess of 30% this year, compared to 19% for the S&P 500 (excluding financials and utilities).
And all of them have outperformed the S&P 500's year-to-date gain of 16%. Other stocks such as Netflix and Newmont Corporation have lagged the S&P 500's year-to-date performance, but could be poised to return to favor among investors amid the prospect for each company's profit margins this year (see above chart).
"S&P 500 margins notched a record high of 11.9% in 1Q 2021, though investors remain focused on the forward margin outlook given rising input costs," Kostin explains.
Strategists are banking on more than the 32 companies outlined by Goldman to expand profit margins this year. The only question is will companies sustain those gains into 2022 given uncertainties around inflation and taxes.
The S&P 500 is seen rising 11.2% over the next 12 months, according to analysis from FactSet. At the sector level, energy and materials are expected to show the largest gains in valuation (17.1% and 15.9%, respectively).
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