As economies around the world remain on pause, it is a given that many of the weakest companies will encounter distress. But the flight into so-called quality stocks has left valuations stretched. So analysts at Goldman Sachs screened stocks that they believe have strong balance sheets and reasonable prices.
The strategy, which Goldman calls “Quality-at-a-Reasonable-Price” is part of a larger way of thinking about investing for the “reopening of the economy.” The analysts also recommend avoiding exposure to small businesses, which are likely to be hit hardest by the lockdowns but least likely to benefit from stimulus — and, separately, to consider buying stocks of goods-producing cyclical companies.
The “Quality-at-a-Reasonable-Price” analysis offers 30 stocks; the top 20 are shown in the table below.
|Company||Sector||Price/2021 EPS||Altman Z-Score|
|Monster Beverage Corp.
|Skyworks Solutions Inc.
|IPG Photonics Corp.
|Regeneron Pharma Inc.
|Texas Instruments Inc.
|Electronic Arts Inc.
|C.H. Robinson Worldwide Inc.
|Home Depot Inc.
|W.W. Grainger Inc.
|Robert Half International Inc.
|Ross Stores Inc.
|Rockwell Automation Corp.
|Source: Goldman Sachs Global Investment Research|
The Goldman analysts explain that the “Altman Z-score” noted in the final column “combines five metrics to assess the likelihood of default: working capital/assets, retained earnings/assets, EBIT/assets, market capitalization/liabilities, and sales/assets.”
Recent analyses suggest defaults among junk-bond issuers could reach anywhere between 8% to 13% by the end of the year.
Goldman’s base-case forecast for defaults, however, is for a rate of 13%, in line with losses suffered as a result of the 2008 financial crisis. But the “downside” estimate is for defaults as high as 18%, a record.
The investment bank ran its valuation screen by using a metric of price divided by 2021 earnings per share, or EPS, “given that we expect substantial revisions to consensus 2020 estimates as the impact of the economic shutdown becomes more clear.” They excluded stocks that ranked in the top 20% of valuations in their respective sectors, and then also excluded those in the bottom 20%, to avoid “value traps.”
Of note, only four energy companies make it through the screen, and all are in the bottom 10 of Goldman’s 30, and thus not noted above.