According to the firm’s chief U.S. equity strategist, David Kostin, companies have been ramping up their cash spending after the corporate tax cut, but that spending isn’t making riskier companies more appealing and investors are currently more attracted to those companies with strong balance sheets.
“Firms boosted total cash spending by 25% to $2.8 trillion in 2018,” Kostin wrote in a note to clients. “However, investors have not rewarded most forms of cash spending during the past 12 months.”
“Recent market performance indicates a clear investor preference for safe, high quality balance sheets rather than firms investing for growth, returning cash to shareholders, or paying down debt,” Kostin said.
With that in mind, Goldman generated a basket of companies in the S&P 500 that are ranked high in terms of working capital to assets, retained earnings to assets, operating income to assets, leverage ratio, and sales to assets. Compared to a similar basket of stocks with weak balance sheets, Goldman’s basket outperformed by 15 percentage points since 2018.
This group of stocks also delivered a 22% return so far this year, beating both the weak balance sheet’s return of 20% and the S&P 500’s 17% gain.
“After two years of steady outperformance, strong balance sheets now trade at an 83% Price to Earnings multiple premium (a 94th percentile reading since 1980) to weak balance sheets,” Kostin wrote.
Stocks in Goldman’s strong balance sheet basket include names like Facebook (NASDAQ: FB), Nvidia (NASDAQ: NVDA), Monster Beverage (NASDAQ: MNST), and fast casual chain Chipotle Mexican Grill (NYSE: CMG).
Of these, Chipotle has gained the most so far this year, and is currently up nearly 60% year-to-date. The stock is currently up just under 100% since its December low.
Late last month, CMG reported its best quarter in years with 9.9% same-store sales growth in Q1, 5.8% transaction growth, and 100% growth in digital sales.
“In our view, the accelerating in transaction growth from 2% in 4Q18 suggests the company’s digital and marketing efforts are resonating with new and lapsed guests,” wrote BTIG analysts, who rate the stock a Buy and have set a price target of $790.
“In our view, this intense focus on improving digital access has been a core pillar of the brands’ success,” the BTIG analysts said. “We expect digital sales mix to continue to improve for the foreseeable future as the company increases the number of locations with digitized second-make line, adoption of loyalty grows and deliver expands.”