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Corporate Profitability Bottoms Out but Unlikely to Increase Significantly, Says Goldman Sachs
Goldman Sachs’ Analysis on Corporate Profitability
A recent analysis by Goldman Sachs indicates that corporate profitability has hit rock bottom in the current economy. However, according to the analysis, it is unlikely for companies to expand their profits and margins significantly within the next year. The research conducted by Goldman Sachs was based on return on equity which indicates the ratio of net income to shareholders’ equity.
Return on Equity
Return on equity is a measure of how successful management has been in extracting profits out of a company’s assets. After declining for four straight quarters, return on equity increased slightly in the first quarter. It is a reflection of the better-than-expected earnings seasons in the first quarter. The chief U.S. equity strategist of Goldman, David Kostin stated in a note that the worst of the profit margin reset is likely behind us.
However, it is unlikely for substantial ROE growth to occur in the near term. Goldman identified slowing price hikes, higher interest rates, and taxes as the major headwinds for corporate profitability. The near-term path of S&P 500 ROE will depend on margin growth according to Goldman Sachs. As such, it is uncertain that profit and margins will expand significantly within the next 12 months.
ROE Growth Basket
Despite this, Goldman has identified a few stocks for clients to buy that are bucking the current trend. The investment bank looked at companies where their analysts expect ROE to expand the most over the next year. Stocks in the basket of “ROE Growth” for clients are expected to experience a median 13% increase in ROE over the next year. While in contrast, the median expectation for decline in the S&P 500 is 9% over the same period.
Companies with Promising Prospects
Disney is among the companies expected to experience a 21% increase in ROE over the next 12 months, according to Goldman Sachs. Meta Platforms, the Facebook and Instagram parent company that is undergoing strenuous cost cuts, has recently been added to the basket, experiencing an 8% ROE expansion per Goldman Sachs analysts.
The Future of AI
Goldman Sachs also believes that artificial intelligence (AI) could change corporate profitability in the long term. The widespread adoption of AI by companies could result in higher productivity across the economy and lead to more earnings than the current baseline forecast, according to Goldman Sachs.
In conclusion, the current state of corporate profitability seems to be bottoming out, but according to Goldman Sachs, it is unlikely for significant expansion of profits and margins to occur within the next year. While there are several headwinds that may impact corporate profitability negatively – slowing price hikes, higher interest rates, and taxes – there are still stocks in the "ROE Growth" basket that are expected to experience an increase in ROE over the next year. Goldman Sachs predicts that companies like Disney and Meta Platforms will experience an 8%-21% increase in ROE, respectively, over the next 12 months. However, it is important for new business owners to stay vigilant and watch out for the potential impacts of these headwinds on their financials, especially considering the current state of the economy. Moreover, as Goldman Sachs suggests, the future of AI can potentially change corporate profitability in the long run. This reiterates the need for new and existing businesses to be technologically well-equipped to stay ahead of the changing market trends. While the present and the short term may look uncertain, businesses must focus on laying down the foundation for long-term growth, as corporate profitability will continue to be impacted by various headwinds and tailwinds.