Top 9 High-Margin Stocks Poised to Thrive in the Fed's New Dovish Era

Goldman Sachs analysts forecast that the Federal Reserve's recent dovish approach will gradually push inflation higher, creating a favorable environment for high-margin companies with significant pricing power. In its latest policy statement, the Fed reaffirmed its expectation of maintaining 2% inflation across core and headline indexes over the next two years, aligning with its long-term goals.

According to a recent Goldman Sachs research report, a select group of stocks that have outperformed significantly over the past year are well-positioned to continue their strong performance in the near future. These high-margin companies are especially resilient amid rising material and labor costs, as well as slowing economic growth, which typically pressure corporate profits during economic downturns.

"Increasing margin pressures have propelled the outperformance of stocks possessing robust pricing power," Goldman Sachs noted. "Our screening of stocks with consistently high and stable gross margins reveals they have outperformed those with limited pricing power by 20 percentage points over the past year."

The firm’s screening identified nine companies with strong and stable margins, indicative of substantial pricing power: Penumbra Inc. (PEN), Amgen Inc. (AMGN), Monolithic Power Systems Inc. (MPWR), National Instruments Corp. (NATI), Citrix Systems Inc. (CTXS), VMware Inc. (VMW), Eli Lilly & Co. (LLY), Expedia Group Inc. (EXPE), and Xilinx Inc. (XLNX). This article is the second in a two-part series analyzing Goldman Sachs’ March 15, 2019 research report.

9 High-Margin Stocks with Strong Pricing Power

• Penumbra Inc. (PEN): 66% (5-Year Average Margin)
• Amgen Inc. (AMGN): 81%
• Monolithic Power Systems Inc. (MPWR): 54%
• National Instruments Corp. (NATI): 74%
• Citrix Systems Inc. (CTXS): 83%
• VMware Inc. (VMW): 85%
• Eli Lilly & Co. (LLY): 75%
• Expedia Group Inc. (EXPE): 74%
• Xilinx Inc. (XLNX): 69%

Source: Goldman Sachs

Rising Input Costs Challenge Corporate Profitability

Goldman Sachs highlights that corporate profit margins, which recently reached record highs, are now facing escalating pressures due to rising input costs. "Profit margins have seen significant downward revisions recently, leading to lower equity earnings per share (EPS) estimates," the firm explained. "Despite the Fed's current policy stance, many U.S. companies struggle to raise prices sufficiently to offset these increasing costs."

As margin pressures intensify, the equity market is increasingly rewarding companies with strong pricing power that can sustain profits by passing costs onto customers. Conversely, firms lacking this ability are losing favor among investors and may continue to underperform, according to Goldman Sachs.

"The accelerated outperformance of stocks with high pricing power this year likely reflects the growing expectation of a Fed pivot toward higher inflation, and the associated risks this poses to corporate profit margins," the report stated.

This trend has resulted in Goldman Sachs’ high-margin stock picks outperforming low pricing power stocks by 17 percentage points (+13% versus -4%) since May 2018. Historically, since 1985, companies with strong pricing power tend to outperform during periods when profit margins are expected to decline. Conversely, during times of expanding margins, such as 2012 to 2017, investors favored stocks with more cyclical margins, reducing the premium on pricing power.

Leading Cloud Computing Firm: VMware

VMware, a leading software and cloud computing provider, has outperformed the broader market substantially in 2019, with shares rising 33.7% year-to-date and 47.4% over the past 12 months. This compares favorably to the S&P 500’s gains of 12.4% and 3.9% over the same periods. VMware boasts an impressive 5-year average margin of 85%, far exceeding the Russell 1000's 35% average and the basket’s median of 56%.

In its recent Q4 earnings report, VMware reported a 16% year-over-year revenue increase to $2.59 billion. Earnings per share came in at $1.87, surpassing analyst expectations of $1.68.

Outlook and Considerations

While these high-margin companies are well-positioned to continue benefiting from investor preferences amid rising costs, a severe economic downturn could negatively impact their performance. Additionally, because this list spans multiple sectors, industry-specific challenges could also affect individual stock returns.

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