Since early October, the stock market has tumbled. The S&P 500, Dow Jones, and Nasdaq have all dropped more than 12%. The Nasdaq leading the descent with a 15% decline. More than that, intra-day swings of more than 1% have become the norm, risks of a recession in 2019-20 are mounting, and the S&P 500’s moving average is sloping downward for the first time since 2016.
Overall, the market outlook isn’t great right now. That’s why Goldman Sachs issued a note on Monday telling clients to position defensively for what could be a turbulent stock market in 2019. Specifically, Goldman recommended that investors pick up a few high-quality stocks for this defensive positioning.
What distinguished these high-quality stocks? Goldman argues that a healthy balance sheet, a high return on equity level, and steady cash flow production are high-quality attributes which should lead to stock price out-performance in 2019.
With that in mind, let’s take look at the three high-quality stocks Goldman Sachs likes for next year.
High-Quality Stocks Goldman Likes for 2019: Alphabet (GOOG)
High-Quality Attributes: $100 billion-plus in cash and less than $5 billion in debt. Stable earnings growth fundamentals as the backbone of digital search. Healthy long-term drivers through automated driving and AI. 16x cash flow, versus five-year median of 18x cash flow.
At the top of Goldman’s list of high-quality stocks to own in 2019 is internet giant Alphabet (NASDAQ:GOOG,NASDAQ:GOOGL). This pick makes a lot of sense. The financials supporting GOOG stock are clean and healthy. The balance sheet is loaded with cash and has very little debt. Cash flows are huge, and the cash flow multiple is below the five year median by a sizable margin. The valuation is reasonable.
Most importantly, the growth fundamentals underlying GOOG stock are stable. Alphabet is essentially the backbone of the modern internet. Through Google Chrome, Google Search, and Gmail, Alphabet is behind the world’s most used internet services. An economic slowdown will dilute ad spend some, but it won’t dilute internet usage. As search, Google’s revenues and earnings should remain largely stable even amid slowing economic expansion.
Also, GOOG stock has healthy long-term drivers which will keep investors around during near-term turbulence. Through its self-driving unit Waymo, Alphabet is the leader in the automated driving space. Moreover, thanks to the company’s robust digital search database, the company has all the resources it needs to be an AI leader.
Overall, GOOG stock has plenty of high quality attributes which should make this stock a relatively safe and defensive pick in 2019.
High-Quality Stocks Goldman Likes for 2019: PepsiCo (PEP)
High-Quality Attributes: 3%-plus dividend yield, versus five-year average yield of below 3%. Resilient earnings growth fundamentals due to consumer staples product portfolio. 19x forward earnings multiple is in-line with five year average. High 40%-plus return on equity.
The second high-quality stock that Goldman recommends for 2019 is global beverage and snack giant PepsiCo (NYSE:PEP). Much like Alphabet, this is a rather obvious choice with strong and healthy financials. The dividend yield is up above 3% and well above where it has hovered on average over the past five years. The forward earnings multiple is in-line with its five year average. PepsiCo’s return on equity is above 40%, and nearly double the market average 22% return on equity.
But, the most attractive high-quality attribute of PEP stock is its stable earnings growth fundamentals. PepsiCo sells a wide portfolio of beverages and snacks around the world. Demand for this portfolio of consumer staples won’t be impacted much by a global economic slowdown. As such, regardless of the broad economic outlook in 2019, PEP stock should be supported by stable earnings levels.
History proves this resilience. During the 2008-09 stock market crash, PEP stock fell just 40%, while the S&P 500 lost more than 55% of its value. During the Dot-Com crash, PEP stock fell less than 20% off highs, while the S&P 500 tumbled nearly 40% off highs.
Overall, PEP stock is supported by multiple high-quality attributes, most notably its operational resilience during economic downturns. As such, this stock is unequivocally a top defensive pick for 2019.
High-Quality Stocks Goldman Likes for 2019: Mastercard (MA)
High-Quality Attributes: stable growth fundamentals as backbone of payments system. Strong profit margins of 35%-plus, versus market-average of 15%. Healthy balance sheet with over $2 billion in net cash. Fairly healthy 3% free cash flow yield.
Goldman’s third pick for high-quality stocks in 2019 is Mastercard (NYSE:MA). The reasoning behind the payments processor as a top defensive pick is strong financials. With Mastercard, you have 35%-plus profit margins on a business that tends to do well so long as the economy is growing. You also have a healthy balance sheet with over $2 billion in net cash, and a fairly strong 3% free cash flow yield alongside a 0.5% dividend yield.
But, the flip-side of this argument is that as goes the economy, so goes Mastercard. This company is a payments processor company. That means that so long as the economy remains healthy and consumers are spending more, Mastercard’s numbers go up. But, when the economy cools and consumers spend less, Mastercard’s numbers go down. Thus, MA stock really isn’t resilient or defensive to an economic slowdown.
Just look at the 2008-09 stock market crash for proof. While PEP stock performed 20 points better during that sell-off, MA stock fell 60% off highs, meaning it dropped just as much as the market.
Overall, MA stock has high quality attributes which are defensive in nature so long as the economy is growing. But, if the economy starts shrinking, those high-quality attributes go out the window because lower consumer spending means lower profits for Mastercard, and a lower price tag for MA stock.
As of this writing, Luke Lango was long GOOG.