The shortfall of bank earnings this week due to higher-than-anticipated expenses prompted me to write about wage-sensitive stocks. The elasticity of operating expenses on a firm’s income statement can be a make-or-break factor for investors. It ultimately dictates a company’s cost of debt and, subsequently, the investors’ remaining residual.
Additionally, the proclivity of market participants to act on recent earnings reports often results in prolonged downward momentum patterns. These need to be analyzed with caution if you want sustainable success as an investor.
With that in mind, these three wage-sensitive stocks should be avoided for now:
- The Goldman Sachs Group, Inc. (NYSE:GS)
- Netflix, Inc. (NASDAQ:NFLX)
- Wal-Mart Stores, Inc. (NYSE:WMT)
Wage-Sensitive Stocks: Goldman Sachs (GS)
Goldman Sachs is one of the largest banking stocks by market capitalization. Its wage bill makes up approximately 29% of its total revenue.
The banking giant released a disappointing fourth-quarter earnings report this week. It missed out on its earnings per share estimate by $1.12.
The investment banking space has been under significant wage pressure lately. Top talent is reluctant to return to long hours at the office unless they get paid significantly more than they did pre-pandemic.
Serious issues can arise at Goldman if this persists. It’s likely that its long-run earnings will take a hit after spiking amid expansionary monetary policy during 2020 and 2021. If this scenario had to pan out, we’d likely see a depletion of fair stock value and subsequent market value.
Furthermore, GS stock is struggling for momentum. It is trading below its 10-, 50-, 100-, and 200-day moving averages. That’s unlikely to shift after a disappointing fourth quarter.
Many probably think Netflix operates a lean staffing model, but it actually employs more than 9,400 individuals. The popular streaming platform’s net income per employee for 2021 was $263,700, in-line with most Fortune 500 firms.
An inflationary wage environment couldn’t come at a worse time for the company, though. The streaming business is becoming increasingly competitive, prompting Netflix to increase its re-investment rate.
The company also upped research and development (R&D) expenses last year. Persistent wage demands could thus diminish the firm’s prospects of creating sustainable shareholder value.
I’m genuinely concerned about Netflix. Its stock is overvalued, and a range of bad earnings reports could expose these fault lines.
I usually look at the price-to-sales ratio when analyzing growth stocks because it’s the least-volatile metric of the bunch. Netflix stock’s price-to-sales ratio is trading at a 5.8x premium, indicating the market has gotten ahead of itself lately.
You could argue many tech stocks have traded at high multiples and turned into multi-baggers. But that was during a decade of expansionary monetary policy with low inflation, and those elements don’t coincide often. An abrupt shift to contractionary monetary policy with stubborn inflation will almost surely cause many high-multiple growth stocks to drop to their fair values.
Wage-Sensitive Stocks: Walmart (WMT)
Walmart hiked its wages three times last year, reporting an average hourly wage of $16.40 versus the retail sector average of $14.87.
The retail giant may seem like an obvious pick considering we’re talking about a firm with more than two million associates. But there’s a serious stock pricing issue at hand amid persistently lower returns to equity holders.
Walmart’s current price-to-book ratio of 4.7x is already overvalued, and I can’t see this narrowing this year. The stock’s return on equity (ROE) is forecast to decrease by 0.24% in 2022 on the back of a 61.42% drawdown in 2021.
This matters because price-to-book ratios above 1x need to be justified by increasing ROE growth and a decreasing cost of capital. Neither of these are happening at the moment.
A final variable worth mentioning is that we’re likely to witness declining growth in retail sales this year amid smoothing GDP growth. I’m unsure whether Walmart will be able to handle the wage pressure without sacrificing a significant amount of investor residual.
On the date of publication, Steve Booyens held long positions in GS, NFLX, and WMT. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Steve Booyens co-founded Pearl Gray Equity and Research in 2020 and has been responsible for equity research and PR ever since. Before founding the firm, Steve spent time working in various finance roles in London and South Africa, and his articles are published on various reputable web pages such as Seeking Alpha, Benzinga, Gurufocus, and Yahoo Finance. Steve’s content for InvestorPlace includes stock recommendations, with occasional articles on crowdfunding, cryptocurrency, and ESG.