As earnings season begins, analysts at Goldman Sachs say the stock market is placing more value on improving net margins.
This has been another excellent year for U.S. stocks -- so far -- as the S&P 500 has returned 17%, following an 18% gain during 2020. Investors know that stocks are anything but cheap, so a good question to ask is what will the market reward for the rest of the year and 2022?
Goldman Sachs analyst David Kostin wrote in the firm's "U.S. Weekly Kickstart" note to clients July 9 that investors have "started to reward companies with attractive margin profiles." By this, he means net margin, which is a company's net income divided by net revenue.
Comparisons of net income margins may be most meaningful within industries, because some by their nature have low margins when measured this way. Kostin wrote: "Our sector-neutral factor of stocks with the highest vs. lowest profit margins has also started to outperform."
He and a team of Goldman Sachs analysts screened the S&P 500 for stocks with "above-average net interest margins, realized margin growth of 50+ bp [basis points] in 2020, and expected margin growth of 50+ bp in each of the next two years."
This led to a group of 32 large-cap stocks in six sectors expected to increase net margins by a median of 201 basis points this year and another 105 basis points in 2022, after defying the odds with profit margin expansion of at least 50 basis points during the pandemic year of 2020. The six sectors were communications services, consumer staples, health care, industrials, information technology and materials.
Stocks that made Goldman's list include Netflix Inc. $(NFLX)$, Broadcom Inc. $(AVGO)$ and Philip Morris International Inc. $(PM)$.
Broad screen
To begin with a larger group of stocks and possibly produce a list with the most upside potential, we began with the S&P Composite 1500 Index , which is made up of the S&P 500, the S&P 400 Mid Cap Index $(MID)$ and the S&P Small Cap 600 Index . We then took an "unfair" approach of screening by net income margin regardless of sector or industry and favoring companies that sailed through 2020.
All the numbers in the screen are for calendar years -- not fiscal years, which for many companies don't match the calendar.
Here's the screen:
Here are the 20 stocks that made the screen with at least 20% upside implied by consensus price targets:
Source: FactSet
| Company | Est. net margin -- 2022 | Est. net margin -- 2021 | Net margin -- 2020 | Net margin -- 2019 | Share "buy" ratings | Closing price -- July 9 | Cons. price target | Implied 12-month upside potential |
| Boston Beer Co. Class A SAM | 13.35% | 12.30% | 11.03% | 8.80% | 53% | $973.58 | $1,352.80 | 39% |
| Dorian LPG Ltd. LPG | 39.31% | 27.80% | 25.02% | 24.37% | 86% | $12.80 | $17.00 | 33% |
| IAA Inc. IAA | 18.31% | 17.29% | 14.07% | 13.45% | 90% | $54.98 | $71.50 | 30% |
| Take-Two Interactive Software Inc. TTWO | 19.42% | 18.42% | 14.96% | 11.81% | 71% | $170.37 | $221.27 | 30% |
| Haemonetics Corp. HAE | 14.80% | 13.82% | 12.23% | 7.98% | 86% | $63.48 | $80.29 | 26% |
| Activision Blizzard Inc. ATVI | 34.57% | 33.36% | 27.16% | 23.30% | 88% | $92.38 | $116.03 | 26% |
| SPS Commerce Inc. SPSC | 17.84% | 16.68% | 14.58% | 12.08% | 67% | $100.77 | $125.29 | 24% |
| FMC Corp. FMC | 19.46% | 18.51% | 12.46% | 11.70% | 79% | $107.66 | $133.12 | 24% |
| First Horizon Corp. FHN | 29.93% | 29.02% | 24.81% | 19.39% | 87% | $16.79 | $20.54 | 22% |
| Applied Materials Inc. AMAT | 27.08% | 26.52% | 21.14% | 18.73% | 76% | $134.90 | $161.92 | 20% |
| Investors Bancorp Inc. ISBC | 35.09% | 34.27% | 21.14% | 17.87% | 71% | $13.70 | $16.29 | 19% |
| Baxter International Inc. BAX | 15.27% | 14.18% | 9.44% | 8.81% | 56% | $80.43 | $94.25 | 17% |
| Cirrus Logic Inc. CRUS | 19.62% | 19.07% | 14.92% | 12.52% | 75% | $85.79 | $100.27 | 17% |
| Parker-Hannifin Corp. PH | 14.48% | 13.97% | 10.60% | 9.63% | 77% | $311.57 | $361.00 | 16% |
| Netflix Inc. NFLX | 17.35% | 16.14% | 11.05% | 9.26% | 76% | $535.98 | $615.69 | 15% |
| Sempra Energy SRE | 21.63% | 21.09% | 18.35% | 16.98% | 60% | $132.86 | $151.13 | 14% |
| Aon PLC Class A AON | 22.18% | 21.42% | 17.79% | 13.92% | 47% | $236.31 | $266.33 | 13% |
| Helen of Troy Ltd. HELE | 14.11% | 13.62% | 11.54% | 10.76% | 40% | $215.25 | $242.50 | 13% |
| Monolithic Power Systems Inc. MPWR | 29.35% | 28.44% | 19.47% | 17.33% | 79% | $382.60 | $428.00 | 12% |
| Analog Devices Inc. ADI | 36.18% | 35.12% | 23.28% | 21.60% | 83% | $166.27 | $185.80 | 12% |