The market's most efficient companies are separating from the pack at a crucial time in the year.
Corporate execution has been excellent once again. Earnings have continued to exceed expectations and are on pace to grow 8% in 2024, according to Goldman Sachs, which also found that returns on equity are hovering close to 21% — one of the highest rates on record.
Wider profit margins and quicker asset turnover have helped solidify returns on equity this year, wrote David Kostin, Goldman's chief US equity strategist, in a late-September note. That's especially impressive, considering that borrowing costs have remained elevated due to lofty interest rates that have only recently started to fall.
However, not all firms are firing on all cylinders heading into the crucial Q3 earnings season and the pivotal 2024 US elections.
The gap between highly efficient companies — as measured by returns on equity — and other stocks in the S&P 500 has widened, Goldman Sachs found. There's a nearly four-percentage-point difference between the index's return on equity and that of the median stock in the index, which Kostin noted is the biggest discrepancy since 1980.
"This gap reflects the fact that profitability has become more concentrated in recent years," Kostin wrote. He pointed out that the spread between stocks with high and low returns on equity has expanded since the financial crisis as companies relied more on leverage and cheap debt.
These discrepancies are also visible across market sectors. Returns on equity have risen most this year for companies in consumer staples, while energy firms have seen a sizable dip in that metric, Kostin remarked. That's further evidence that stock-picking is especially vital right now.
"The wide dispersion in changes in sector profitability mirrors the relatively healthy stock-picking environment this year amid a more micro- rather than macro-driven market," Kostin wrote.
Notably, this trend of widening gaps in returns on equity may be reversing as interest rates fall and labor costs grow at a slower pace while inflation fades. This efficiency metric may also be swayed by corporate tax policy, which may change based on the outcome of the 2024 elections.
25 increasingly efficient stocks to targetIn his weekly note, Kostin shared an updated list of 50 stocks set to enjoy the largest growth in returns on equity. Analysts expect these firms to grow returns on equity by 15%, versus 2% for the typical stock in the S&P 500. As a whole, these companies also trade at a modest discount to the broader index and have outperformed the median stock in 2024 by 4 percentage points.
To help investors find the cream of the crop, Business Insider trimmed the list further by only including stocks that are growing returns on equity faster than the median stock on the list.
Below are the 25 companies that made the cut, along with the ticker, market capitalization, price-to-earnings (P/E) ratio, sector, expected earnings growth for 2024, forward returns on equity, and return on equity growth for each.