Two heavyweight Wall Street strategists have unwittingly squared off with wildly different market forecasts. Investors should choose options from each of their lists of preferred stocks.
David Kostin is the chief U.S. equity strategist at Goldman Sachs. On Wednesday, a report from Mr. Kostin raised his 2017 target for U.S. equity markets but also reiterated his forecast that the S&P 500 will finish the year lower than current levels.
Mr. Kostin says that U.S. economic growth will be "steady but unspectacular" through 2019. Secular growth companies (those not dependent on economic activity for growth), he writes, "perform best in an environment of modest economic growth as investors gravitate to companies capable of growing sales independent of the pace of GDP growth."
Mr. Kostin says the number of companies capable of generating significant profit growth will be low for the foreseeable future, and investors will continue to flock to stocks that do manage to improve earnings. As the table, below, of his top stock picks highlights, Mr. Kostin is thus unfazed by stocks with high valuations (or even stocks without trailing earnings necessary to calculate price-to-earnings ratios) as long as sales growth remains strong. With his projected slow-growth economic backdrop, more investors are set to buy the already-expensive growth stocks as they are unable to find growth elsewhere, and they will become even more expensive.
Savita Subramanian, chief equity and quantitative strategist at Merrill Lynch, presented a decidedly different set of recommendations in a research report also released Wednesday. Ms. Subramanian writes, "We prefer underowned value [stocks] to crowded growth, and screen for relatively underweight stocks with attractive valuations and positive [analyst earnings] revisions versus expensive, crowded secular growth stocks with poor revisions."
Ms. Subramanian's list of stocks to avoid (not shown) – those with high valuations, widely owned in money manager portfolios, and negative short-term earnings revisions – contains Netflix Inc., Amazon.com Inc. and Google parent Alphabet Inc. These are stocks on Mr. Kostin's buy list.
The Merrill Lynch stock recommendations in the second, lower table is a who's who of attractively valued companies neglected by both investors and business media, but have nonetheless been able to improve their earnings outlook. H&R Block Inc., D.R. Horton Inc., PulteGroup Inc., and Kohl's Corp. top the list.
I think there's ample reason for investors to choose stocks from both lists – it's not a "someone's totally right and someone's totally out to lunch" question. Each list suits different purposes, investors and market environments.
Risk-averse investors should focus more on the Merrill Lynch list where low valuation levels should provide a higher degree of downside price protection. But, if Mr. Kostin's sustained slow-growth forecast becomes reality, it may take a long time for these value companies to reward investors with higher stock prices.
Mr. Kostin's stocks imply far more risk than Ms. Subramanian's but also higher growth and return potential. Over the longer term, the Goldman Sachs picks are more likely to fall as the lofty expectations imbedded in expensive valuation levels aren't met, but market tops are difficult to identify and this could happen well into the future.
None of us know what economic and market conditions will look like in the future, so a portfolio holding both growth and value investments, tilted to reflect different investor risk tolerances and time horizons, is the best course.
These two stock lists offer a credible opportunity to accomplish this.
Goldman Sachs Strategy: Top Picks
|Company||Symbol||YTD Total Return (%)||Total Return 12M (%)||P/E Ratio TTM||Forward P/E Ratio||EV/Sales||GS Estim. Sales Growth 2018 (%)|
|Pure Storage Inc.||PSTG-N||15.83||29.06||N/A||N/A||2.85||29|
|Palo Alto Networks Inc.||PANW-N||7.74||13.86||N/A||44.11||6.97||21|
EV = enterprise value; TTM = trailing 12 months. Source: Bloomberg; Goldman Sachs
Merrill Lynch Strategy: Top Picks
|Company||Symbol||YTD Total Return (%)||Total Return 12M (%)||P/E Ratio TTM||Forward P/E Ratio||EV/Sales|
|H&R Block Inc.||HRB-N||36.97||43.87||15.11||15.32||2.27|
|DR Horton Inc.||DHI-N||25.50||14.10||12.88||12.12||1.11|
|Best Buy Co. Inc.||BBY-N||34.90||94.35||15.16||14.45||0.38|
|CVS Health Corp.||CVS-N||4.31||-11.43||14.95||13.64||0.60|
|Regions Financial Corp.||RF-N||-0.74||75.16||15.55||14.14||N/A|
|Raymond James Financial Inc.||RJF-N||16.17||71.95||17.60||15.04||1.84|
EV = enterprise value; TTM = trailing 12 months. Source: Bloomberg; Merrill Lynch