By Jacob Sonenshine
The stock market can't get out of its own way right now. Shares of the most unprofitable companies are most at risk.
As of Thursday morning, the S&P 500 had dropped just over 4% from its March 28 record closing high. The Russell 2000, an index of companies with smaller market capitalizations, was down 8%.
But this doesn't mean the losses are over or that it makes sense to indiscriminately buy stocks. Additional declines are more than plausible, so it makes sense to look for the companies that are best positioned to ride out a rough patch.
Neither index has truly stabilized. In recent days, each has repeatedly begun trading in positive territory, only to end in the red. That means sellers are coming in quickly to knock prices lower, a pattern that reflects a lack of confidence that stocks will post sustainable gains.
Even the morning moves upward are mild. The indexes opened Thursday up only a few tenths of a percent, which is another sign of limited buying interest.
That makes sense because new risks have cropped up. The rate of inflation has remained stubbornly high, which means the Federal Reserve is unlikely to cut its target for the federal-funds rate soon, as policymakers have made clear. In response, market interest rates have moved upward in the past few weeks, which threatens to slow down growth in the economy and for corporate earnings.
Combine that with the fact that the S&P 500 still trades at roughly 20 times the aggregate per-share earnings analysts expect its component companies to produce in the coming 12 months. That is at the high end of its range since the Fed started hiking rates in early 2022, and it means any disappointment about the outlook for profits would push stocks downward.
That is awful news for small-caps. Smaller companies' performances tend to be more volatile than those of larger ones: They often have heavier debt burdens, but less flexibility to cut costs aggressively when sales take a hit. That is why "investors haves shown a strong preference for profitable names," wrote 22V Research's Dennis DeBusschere on Monday.
The smaller-cap indexes have a greater percentage of stocks that have been running at net losses recently versus the S&P 500, according to 22V Research.
To find the safer plays, Barron's screened for the S&P 500 companies with the 50 highest operating profit margins in 2023. Those businesses will still produce profits even if sales take a hit. They have minimal risk of defaulting on debt payments, one factor making their stock prices less volatile.
Our list includes households name such as Visa and McDonald's. As of Thursday morning, they were only down about 2.5% and 3.9%, respectively, since late March.
CME Group had fallen 2.7% and S&P Global had dropped 2.6%, while Broadcom's loss was about 3.3%. Microsoft has slid 2.8%, while Meta Platforms has gained just over 4%.
Some tech names that made the list, such as Nvidia, have dropped more than the S&P 500 because so many fund managers had already loaded up on them, making them particularly vulnerable to selling. But many of these names will hold strong.
Anyone who is tempted to buy stocks should look to the higher-quality and more profitable ones. Those are unlikely to face the steepest drops.
Write to Jacob Sonenshine at jacob.sonenshine@barrons.com
This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.
(END) Dow Jones Newswires
April 18, 2024 13:47 ET (17:47 GMT)
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