Goldman Sachs has a ‘low labor costs’ stock strategy that beats the market

Rising wages are expected to eat into corporate profit margins, weighing on companies that are already projecting much slower growth. But Goldman Sachs said some stocks should be immune to higher labor costs.

January jobs report pointed to a 3.2 percent year-over-year increase in wage growth, around the highest levels in the economic recovery. Rising wages are beginning to force companies to pass on the costs through higher prices, threatening to slow corporate revenue growth even further. However, some companies have very low exposure to labor costs and they should beat the market as wages remain a margin headwind, according to Goldman.

“A tightening labor market and rising wages add to pressure on corporate profit margins,” the bank’s equity strategist Ben Snider said in a note on Tuesday. “Stocks with the lowest labor cost exposure should outperform as wages continue to rise.”

The bank put together a basket consisting of 50 of the S&P 500 companies with the lowest ratio of labor costs to revenues. Labor costs account for 6 percent of revenue on average for the basket’s stocks, compared to 14 percent for the S&P 500 overall. The basket outperformed the S&P 500 by more than 20 percentage points from early 2016 through mid-2018 when wage growth stoked inflationary pressure, pushing break-even inflation to 2.2 percent from 1.2 percent, Goldman Sachs said.

Companies are now faced with a list of margin headwinds including rising wages, slowing revenue growth and tariffs after an easy 2018 when pro-business tax policies boosted corporate profits. Wall Street analysts are slashing earnings expectations for 2019 so sharply that estimate for the first-quarter earnings growth has turned negative, while consensus for net profit margins fell to 10.9 percent in 2019, down from a record high of 11.2 percent in 2018.

Goldman Sachs’ basket has outperformed the S&P 500 by 3 percent year to date, and the bank expects it to continue to beat the market as U.S. economic growth stabilizes.

The low labor cost basket from Goldman for clients include stocks such as Western Union, Mastercard, Paypal and Marathon Petroleum. The firm calculates labor costs are just 1 percent of revenue for Marathon, an oil refiner.

The Goldman basket also includes some names from the services and retail industry where labor costs are thought to be quite high. Those names include Host Hotels & Resorts, Under Armour and Gap.