Goldman Sachs strategist David kostin and the team notes that stocks with high operating leverage–Amazon.com (AMZN), Whole Foods Market (WFM), ConocoPhillips (COP), Yahoo! (YHOO), and FedEx (FDX) among them – will outperform if the US economy strengthens:
Discussions with clients this week focused on economic growth, operating leverage and wage inflation. Goldman Sachs Economics’ US Current Activity Indicator (CAI) is a proxy for real-time GDP growth and the measure has slowed to 1.3%. Our fellow economists expect GDP growth to accelerate at a rate of 3.2% in Q2 and 2.3% on average in Q2 2016. Companies with the highest operating leverage should benefit the most. plus the acceleration in GDP growth and the associated recovery in sales growth. Conversely, investors who fear the economy could slow and see last week’s dismal 38,000 jobs report as a harbinger of weakening activity should hold stocks with the weakest. degree of operating leverage.
A business with a high degree of operating leverage has high fixed costs compared to variable costs. We calculate the degree of operating leverage (DOL) of each company as the ratio of revenue after variable operating costs to revenue after variable and fixed operating costs [DOL = (Sales â COGS) / (Sales â COGS â SGA â Depreciation)]. Operating leverage has trended downward since 1990, but has recently increased to the long-term average …
Low operating leverage stocks outperformed high operating leverage from June 2014 to February 2016 by 800 bps (-2% vs. -10%; S&P 500 reported -3%). However, since mid-February, our industry-neutral high operating leverage basket of 50 stocks (ticker: GSTHOPHI) has returned 23%, exceeding our leverage basket of 50 stocks. Low exploitation (GSTHOPLO) (+ 17%) of 600bp (the S&P 500 returned 17% during the same period). We expect this trend to continue.
Here is the Goldman Sachs list of the 50 stocks with high operating leverage …
… and the 50 with low operational leverage:
Amazon.com shares were up 0.1% to $ 718.66 as of 2:20 p.m. today, while Whole Foods Market fell 2% to $ 33.62, ConocoPhillips fell 1.3% to $ 43.94, Yahoo! was down 0.5% to $ 36.65 and FedEx was down 0.1% to $ 160.66.