The wild swings in the S&P 500, plunging 5% last week and rallying 5% the week earlier, have shaken investors as they watched their stock gains evaporate for the year. With that in mind, Goldman Sachs has identified 50 quality stocks in the S&P 500 Index (SPX) “with the highest prospective risk-adjusted returns.” Discussing what they call their High Sharpe Ratio basket of stocks, Goldman says, “The median constituent is expected to post 2x the return as the median S&P 500 stock with only modestly higher volatility.” They add, “Resilient analyst price targets reflect ongoing confidence in the companies’ fundamentals.”
The Sharpe ratio, used widely on Wall Street, was developed by Nobel laureate William F. Sharpe, and is used to help investors understand the return of an investment compared to its risk. The ratio is the average return earned in excess of the risk-free rate per unit of volatility — or total risk.
Among Goldman’s 50 stocks in this group, we are highlighting the eight companies with the highest expected Sharpe Ratios, or prospective risk-adjusted returns. These stocks are in a wide range of industries such as apparel retailing, oil exploration, oil services, biotech and construction engineering. They are Michael Kors Holdings Ltd. (KORS), Nektar Therapeutics (NKTR), Newfield Exploration Co. (NFX), News Corp. (NWSA), Schlumberger NV (SLB), Halliburton Co. (HAL), Fluor Corp. (FLR) and Quanta Services Inc. (PWR), per Goldman’s latest US Weekly Kickstart Report.
Significance For Investors
Goldman says its basket has dramatically outperformed the market during most six-month periods. “For tactical investors, our rebalanced High Sharpe Ratio basket (GSTHSHRP) represents a value screen with a quality overlay. The basket has lagged S&P 500 by 10 pp YTD but has outperformed in 68% of 6-month periods since 1999. “
They define quality stocks as those with strong balance sheets (low debt), stable growth in sales and profits, and a low propensity for big share price declines. Goldman’s prospective returns for the eight stocks listed above are, based on consensus price targets:
Nektar Therapeutics, 113%
Newfield Exploration, 107%
Looking beyond this group, Goldman advises in general, “We recommend investors own ‘quality’ in 2019 given elevated risk.” Among the reasons: “Looking into 2019, we expect a continued environment of low risk-adjusted US equity returns.” While Goldman still expects the S&P 500 to post solid gains in 2019, the firm notes that the market is pricing in lower expectations for economic growth than they are forecasting.
Investors who follow Goldman’s recommendations may need strong stomachs. All eight of the stocks listed above have dropped by considerably more than the S&P 500 as a whole so far in 2018, with year-to-date negative returns ranging from 17% to 47%. Indeed, Goldman does note that, overall, the stocks in this basket tend to have “experienced substantial price declines.” When, or if, the expected turnaround in their fortunes takes place is unclear. Should the market remain in a general downtrend, it may prove difficult, if not impossible, for these stocks to swim against the tide.