These 12 stocks are behind Goldman's S&P 500 optimism - and Micron stands out

By Philip van Doorn

Goldman expects corporate profit margins to increase through 2026. A stock screen highlights companies whose gross margins have already improved for four straight quarters.

On Monday, analysts at Goldman Sachs raised their price target for the S&P 500 for the third time this year. They now expect the U.S. large-cap benchmark index to rise to 6,300 over the next 12 months, which would be a 10% gain from Friday's close at 5,751.07.

Maybe the decision to raise the price target for the S&P 500 SPX isn't a surprise, since the index has already risen 21% this year, following a 24% gain last year. But what may be of interest to investors is the firm's expectation that corporate profit margins will improve at an accelerating pace through 2026.

To put those gains into a bit more perspective, keep in mind that the S&P 500 fell 19% in 2022, as rising interest rates took their toll. From the end of 2021, the index was up 21% through Friday. (All price changes in this article exclude dividends.)

With Friday's employment report signaling a good economic backdrop and the Fed no longer raising interest rates, investors might wonder which companies have already been improving their profit margins steadily.

Stock screen - gross margins

A company's gross margin is its net sales, less the cost of goods or services sold, divided by sales. Net sales are sales minus returns and discounts, such as coupons. The cost of goods or services sold includes the actual expenses when making the items or providing the services. Gross margin is a measurement of pricing power.

Financial media coverage of corporate results typically centers on comparisons of year-over-year numbers, which can be especially important for seasonal businesses. But if we look only at gross margins, a comparison of sequential quarterly numbers can shed light on competitive or cyclical trends.

Starting with the S&P 500, gross margin data for the past five quarters is available for 452 companies. This data isn't available for most banks and insurance companies, which have their own industry-based profitability metrics.

Among the S&P 500, only 12 companies have shown sequential improvement of gross margins for four straight quarters. Here they are, listed alphabetically.

   Company                                 Ticker    Quarterly gross margin  Gross margin - Q-1  Gross margin - Q-2  Gross margin - Q-3  Gross margin - Q-4 
   Amphenol Corp. Class A                  APH                       33.61%              33.44%              33.07%              32.77%              32.47% 
   Avery Dennison Corp.                    AVY                       29.65%              29.39%              28.24%              27.92%              26.47% 
   Church & Dwight Co. Inc.                CHD                       45.09%              43.65%              42.56%              42.26%              41.80% 
   Colgate-Palmolive Co.                   CL                        60.68%              59.94%              59.45%              58.66%              57.88% 
   Digital Realty Trust Inc.               DLR                       23.89%              23.08%              22.05%              21.23%              20.71% 
   Ecolab Inc.                             ECL                       43.76%              43.32%              42.11%              41.23%              39.53% 
   Kraft Heinz Co.                         KHC                       35.55%              35.16%              34.71%              34.25%              33.85% 
   Micron Technology Inc.                  MU                        35.32%              26.90%              18.53%              -0.74%             -10.85% 
   Pentair plc                             PNR                       39.83%              38.35%              37.36%              36.99%              36.91% 
   Trimble Inc.                            TRMB                      59.65%              59.47%              58.83%              58.39%              57.63% 
   Union Pacific Corp.                     UNP                       45.41%              45.12%              44.84%              42.85%              42.80% 
   Universal Health Services Inc. Class B  UHS                       11.17%              10.11%               8.94%               8.01%               7.90% 
                                                                                                                                            Source: FactSet 

Many companies have fiscal quarters that don't match the calendar, so there are no dates on the table. The most recent reported quarter is to the left, with the previous quarter labeled "Q-1," etc.

For Micron Technology Inc. (MU), the earliest two quarterly gross margins on the table are negative because the company's cost of goods sold was inflated by inventory write-downs. Also contributing to Micron's negative gross margins for those quarters were extraordinary expenses as it developed new memory products to support the implementation of graphics processing units (or GPUs, mainly sold by Nvidia Corp. (NVDA)) by data centers to support the development of generative artificial intelligence technology.

With these margin improvements, investors might want to see how the stocks' forward price-to-earnings valuations (based on rolling consensus 12-month earnings estimates) compare to historical levels. Here is the list again, in the same order, showing year-to-date price changes, current P/E and those levels relative to long-term averages. For comparison, the same data for the S&P 500 is at the bottom of the table

   Company                                 Ticker    2024 price change through Oct. 4  Forward P/E  Current P/E to 5-year average  Current P/E to 10-year average  Current P/E to 15-year average 
   Amphenol Corp. Class A                  APH                                    26%         31.3                           111%                            123%                            136% 
   Avery Dennison Corp.                    AVY                                     6%         20.9                           106%                            113%                            124% 
   Church & Dwight Co. Inc.                CHD                                     7%         27.6                            99%                            104%                            115% 
   Colgate-Palmolive Co.                   CL                                     24%         26.0                           108%                            111%                            120% 
   Digital Realty Trust Inc.               DLR                                    17%        111.5                           111%                            131%                            154% 
   Ecolab Inc.                             ECL                                    27%         34.0                           100%                            115%                            127% 
   Kraft Heinz Co.                         KHC                                    -6%         11.0                            84%                             67%                             67% 
   Micron Technology Inc.                  MU                                     20%         10.9                            56%                             78%                             57% 
   Pentair plc                             PNR                                    32%         20.4                           120%                            139%                            154% 
   Trimble Inc.                            TRMB                                   17%         20.9                            93%                             99%                            103% 
   Union Pacific Corp.                     UNP                                    -3%         19.6                            99%                            107%                            115% 
   Universal Health Services Inc. Class B  UHS                                    41%         12.3                           103%                             92%                             94% 
   S&P 500                                 SPX                                    21%         21.6                           109%                            118%                            131% 
                                                                                                                                                                                  Source: FactSet 

On the last row of this table, you can see that the S&P 500 as a whole has gotten more expensive over recent years on a forward P/E basis. Seven of the 12 stocks trade above their five-year forward P/E averages, according to FactSet's data. Eight are trading above their average 10-year levels and nine above their 15-year average valuations.

Micron is an interesting exception, trading at the lowest P/E for any company on the list, and lowest to the longer-term averages. It seems clear the market as a whole still doesn't fully trust Micron and its cyclical business, despite this year's upswing for the shares.

(MORE TO FOLLOW) Dow Jones Newswires

10-07-24 1055ET

Copyright (c) 2024 Dow Jones & Company, Inc.