The great reckoning has begun on Wall Street.
Investors are sifting through the economic rubble of this new recession to identify winners and losers in an economy that has rapidly split into a stay-at-home virtual one and a traditional physical one. The bifurcation creates special challenges for one of the Street’s most popular business lines: wagering on stocks ahead of earnings.
“Complexity obscures new underlying trends,” Goldman Sachs derivatives strategist John Marshall wrote in a recent note.
The Covid-19 recession is more complex than a normal one because the virtualization of businesses, lockdowns, government aid, and changes in supply and demand are pulling at short- and long-term profitability. The usual tools for evaluating risk and opportunity are thus less helpful, Marshall said.
Anyone who uses historical trends to predict earnings will likely be slow to adjust to the new realities and lag analysts who can evaluate strategic changes at individual corporate levels, he added.
If he’s right, it means that a change is under way in the very nature of the stock market and how participants make investment decisions. Rather than simply buy a low-cost index fund, investors may increasingly favor individual stocks.
Still, stocks in the S&P 500 index have moved 4.2%, up or down, over the past eight quarters on the day earnings are reported. So far this earnings season, stocks have made the same moves, suggesting investors have yet to adjust to the new realities.
Goldman has identified 12 stocks that the bank’s analysts are confident will report earnings over the next year that are better than the Street expects. They have average earnings-per-share upsides of 17% in the next quarter and 15% over the next year, according to the bank’s analysts.
Goldman’s picks include Allstate (ticker: ALL), Morgan Stanley (MS), Baxter International (BAX), Iqvia Holdings (IQV), Boeing (BA), Parker Hannifin (PH), United Rentals (URI), Whirlpool (WHR), Peloton Interactive (PTON), T-Mobile US (TMUS), Twitter (TWTR), and Western Digital (WDC).
Consider Peloton. The bank is telling clients that the Covid-19 crisis has permanently accelerated new and expanding existing categories of connected fitness products. New competitors and shifting tastes are a risk, but Goldman analyst Heath Terry sees the window of challenge closing and calls Peloton underappreciated, with high profit margins and a low-churn subscription business. The stock has advanced 59% this year, but Terry sees an additional upside of 43%.
Goldman advised clients to consider buying the October $50 call option that covers August earnings. With Peloton’s stock at $45.17, the call cost $7. If the stock is at $65 at expiration, the calls are worth $15. The trade fails if the stock is below the strike price at expiration. During the past 52 weeks, shares have ranged from $17.70 to $47.83.
Morgan Stanley is also better situated than understood. The stock is down 27.6% this year, but Goldman analyst Richard Ramsden calls it the best-positioned bank in a recession and able to withstand interest rates at zero.
He notes that the bank’s net interest income—essentially what banks earn and pay on loans and interest-rate accounts—is about 10% versus a 50% average for the group. The loan business is similarly only 15% of its balance sheet, compared with 40% for the group, which shelters it from loan losses. Ramsden sees the stock gaining 22% over the next 12 months because of its lower interest-rate risk and attractive valuation.
Goldman advised clients to consider buying the September $39 calls. With the stock at $37, the calls cost $3. If the stock is at $48 at expiration, the calls are worth $9. The trade fails if the stock is below the strike price at expiration. During the past 52 weeks, shares have ranged from $27.20 to $57.57.
Corrections & Amplifications
If Morgan Stanley stock is at $48 when the September $39 call options expire, the calls are worth $9. An earlier version of this article mistakenly said they would be worth $11.
Originally Posted on May 14, 2020 – Peloton, Morgan Stanley, and 10 More Stocks for the Covid-19 Era
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