- Small caps are set to have a tough time with Fed tightening, according to Goldman Sachs.
- The bank has highlighted 26 small cap stocks that offer the best chance of outperforming despite this.
- They looked at profit margin and growth expectations, as well as valuations.
This is probably the biggest concern for most investors right now: monetary policy is tightening and interest rates are rising.
More hawkish politics means more resistance to economic growth (likely bad for stocks), and higher interest rates and bond yields mean more attractive, risk-free alternatives to stocks (also bad for stocks).
Certain sectors of the stock market, however, tend to do better than others in such an environment. Small caps — or companies with a relatively smaller market capitalization, roughly between $300 million and $2 billion — typically underperform the rest of the market when conditions tighten, according to a Monday note to Goldman clients. Sachs.
“Looking ahead, tighter financial conditions, slowing growth and a flattening yield curve are all expected to put pressure on Russell 2000 returns relative to the S&P 500,” said David Kostin, strategist. in chief of the bank’s US shares, in the note. The Russell 2000 Index is often used to measure the performance of small caps.
“Over the past 20 years, the Russell 2000 has generated a return very similar to that of the S&P 500,” he continued. “However, the small cap index has underperformed on average during periods when the yield curve is flattening, economic growth is high and falling, or financial conditions are tightening. These three dynamics describe the outlook for 2022. of our economists.
Yet, although generally riskier than their larger counterparts, small caps can offer opportunities for higher returns as they are still relatively small businesses. So, for investors still looking for opportunities in the space, Goldman recommends paying attention to a combination of three things: strong growth in sales and profit margins projected for 2023, and relatively low valuations.
In the note, the bank’s equity strategists compiled a list of small-cap stocks that look attractive based on these three criteria. The list includes actions with a
of at least $1 billion, expected sales growth of more than 10% in 2023 and expected profit margins in 2023 of more than 10%. For the assessment, they included companies with “below average” enterprise value-to-sales ratios in 2023.
The bank also said these stocks could do well in a downturn in the market.
“If the environment becomes so difficult that investors significantly de-risk portfolios, less-held small caps could outperform as they did during the unwind in late 2000 and 2001,” Kostin said.
The 26 stocks included in the rating are listed below in descending order of their projected 2023 profit margins. All have market capitalizations of $5 billion or less.