Rising wages are putting pressure on corporate profit margins, but Goldman Sachs has a low labor cost basket that’s outperforming the market.
Workers are starting to be paid more and that has some investors worried that this wage inflation could take a bite out of corporate profits.
The January jobs report showed a 3.2% year-over-year increase in wage growth – near the highest level seen during the economic recovery since the Great Recession. And as wages rise, corporate revenue growth could slow even further.
But Goldman Sachs (NYSE: GS) says some stocks will be immune to higher labor costs.
These companies have lower exposure to labor costs and, according to Goldman, should beat the market as wages continue to be a margin headwind.
“A tightening labor market and rising wages add to pressure on corporate profit margins, “ wrote Ben Snider, an equity strategist at the firm, in a note from Tuesday. “Stocks with the lowest labor cost exposure should outperform as wages continue to rise.”
The investment bank has developed a basket of 50 stocks that have the lowest ratio of labor costs to revenue. This basket has outperformed the S&P 500 by more than 20% from early 2016 through mid-2018 when wage growth spurred inflationary pressure, pushing inflation to 2.2% from 1.2%, according to Goldman Sachs.
Year-to-date, the basket has outperformed the S&P 500 by 3% and Goldman expects it to continue to outperform as economic growth stabilizes in the U.S.
Names on the list include stocks such as Marathon Petroleum (NYSE: MPC), Mastercard (NYSE: MA), PayPal (NASDAQ: PYPL), and Western Union (NYSE: WU). For Marathon Petroleum, Goldman says labor costs are as low as 1%.
The low labor costs basket also includes a few names from the services and retail industries, where labor costs are typically higher, namely Gap (NYSE: GPS), Host Hotels & Resorts (NYSE: HST), and Under Armour (NYSE: UAA).
Goldman recently released a report that included stocks that the firm believes will outperform even in a recession. Analysts looked for stocks that had exploding margins despite the late-cycle environment we’re in now.
PayPal was included as one of these stocks, making it both a low labor cost stock and a stock that the firm believes will outperform in a recession. This double whammy could make the stock a big winner this year and beyond.
Cantor Fitzgerald analyst Joseph Foresi said that “PayPal can grow at roughly double market average, supporting its premium to the group.” What’s more, the stock currently has 25 Buy ratings and earlier today, BTIG Research boosted its price target for the stock to $114 – nearly 20% higher than Tuesday’s closing price.