REUTERS
- Goldman Sachs' US equity chief says companies with strong financial positions and inexpensive valuations can provide some of the safety investors crave in a "chaotic" stock market.
- David Kostin points out that most companies haven't updated their forecasts to account for the economic contraction caused by the COVID-19 outbreak.
- While that might seem like a secondary consideration right now, companies will start reporting their earnings and updating forecasts in less than a month, and Wall Street will react when that happens.
- That means this might be the ideal time for investors to get their portfolios in order.
- Visit Business Insider's homepage for more stories.
If corporate earnings are the main source of fuel for the stock market, it's become almost impossible to tell how much gas is in the tank.
With the COVID-19 pandemic spreading around the world, with and one out of every five people living under some form of lockdown, typical market milestones like earnings might seem quaint. But US earnings reports will start in about a month, and Wall Street has less idea than usual what to expect.
"Despite the sharp slowdown, few companies have reduced or withdrawn EPS guidance for 1Q, 2Q, or full-year 2020," said David Kostin, chief US equity strategist for Goldman Sachs.
With a recession looming, a lot of forecasts will be slashed. And Kostin adds that stock buybacks, a critical part of the 2009-2020 bull market, will also be sharply curtailed.
It's difficult to get an exact sense of what all of that will do to stocks, which makes it hard to take into account when investing. But Kostin says it's still possible to find the safest companies to bet on. They share these three key characteristics:
(1) Size and liquidity
"In uncertain times, investors seek liquidity, which in practical terms means an above-average market cap," Kostin said.
For that reason he's zeroed in on companies that are large even compared to the S&P 500, where the smallest company is worth about $3 billion and the median company is worth $16 billion.
Just as important, they're more liquid than the typical S&P 500 company as well.
(2) Balance sheet strength
Kostin notes that companies with stronger balance sheets are already outperforming in a major way, which is a big reversal from the pattern that held for most of the 10-year bull market.
"As liquidity in the credit markets falls, companies with the strongest balance sheets are in the best position to weather the negative cash flow resulting from the economic shutdown," he wrote. He identified them based on Altman Z-Scoring, which blends five financial metrics to evaluate each company's risk of insolvency.
(3) Margin of safety
The group got creative to find the companies with the most to gain as GDP slows and earnings forecasts are slashed.
To determine each company's margin of safety, the Goldman team looked at consensus earnings per share estimates for 2021 and reduced them by 20%. That reduced earnings number was compared to the stock's closing price on March 20 to calculate a kind of worst case price to earnings ratio.
That worst case number was then evaluated against to the companies' P/E ratios from the market's last cycle low, which was on March 9, 2009. Comparing the 2021 and 2009 P/E ratios allowed Kostin and company to find a few stocks that look even less expensive than they did during the last major market crisis.
"Simply put, in the words of Ben Graham, these companies offer investors a "Margin of Safety" from a valuation perspective that is certainly appropriate for the current chaotic investment environment," Kostin wrote.
Without further ado, here are 14 such stocks, ranked from smallest to largest based on the size of that discount. The list ultimately highlights which stocks might have the most to gain, and the least to lose.
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