Higher Rates, Lower Leverage: Growth Stocks To Struggle While AI Offers Hope, Goldman Sachs Analysts Say

S&P 500 companies typically boast long-maturity, fixed-rate debt structures. But recent data paints a concerning picture. Over the past year, borrowing costs for corporations surged.

Goldman Sachs’ historical analysis unveils the importance of interest expenses and leverage in bolstering S&P 500’s return on equities (ROE).

Since 1975, these factors have contributed to about a fifth of the overall 8.8-point increase in ROE.

Notably, a recent Federal Reserve paper underscores the profound influence of lower interest expenses and corporate tax rates in driving over 40% of the real growth in corporate profits from 1989 to 2019.

“A scenario in which interest expense and leverage persistently weigh on ROE would
be a departure from the historical trend,” Goldman Sachs wrote in the note.

According to the Goldman Sachs equity team, there may be challenges ahead for ROE growth stocks as worries about increasing interest rates and the ripple effects of rising inflation, driven by surging oil prices, loom on the horizon.

Goldman Sachs Stock Selection

Navigating these turbulent waters, Goldman Sachs has identified a selection of S&P 500 stocks that promise resilience amid a high-rate environment.

Among these are Cisco Systems, Inc (NASDAQ:CSCO), Visa Inc (NYSE:V), BlackRock, Inc. (NYSE:BLK), CME Group Inc. (NASDAQ:CME), Johnson & Johnson (NYSE:JNJ), and Mastercard Incorporated (NYSE:MA).

These companies align with Goldman Sachs’ criteria of low leverage, high-interest coverage, and low EBITDA growth variability, presenting a potential lifeline for investors amidst the prevailing uncertainty.

Goldman Sachs: AI Will Be A Game Changer

An intriguing wildcard emerges in the form of artificial intelligence (AI). Goldman Sachs’ analysis suggests that AI holds the potential to ignite substantial profitability growth for U.S. corporations.

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While S&P 500 companies currently sit in the 97th percentile in terms of ROE within historical context, AI-driven revenue increases and productivity enhancements could propel the trajectory of S&P 500 annual average EPS growth by 50 basis points over the next two decades, reaching 5.4%.

While the precise timing of AI’s transformative impact remains uncertain, several forward-thinking companies are already exploring its potential.

Goldman Sachs’ AI basket spotlights three groups of companies: Enablers, including NVIDIA Corp. (NASDAQ:NVDA), Marvell Technology Group Ltd. (NASDAQ:MRVL), and CrowdStrike Holdings Inc. (NASDAQ:CRWD); Hyperscalers, featuring Microsoft Corporation (NASDAQ:MSFT), Alphabet Inc. (NASDAQ:GOOG), (NASDAQ:GOOGL), and Amazon.com Inc. (NASDAQ:AMZN); and Empowered Users, comprising Meta Platforms Inc. (NASDAQ:META), Salesforce.com Inc. (NYSE:CRM), Adobe Inc. (NASDAQ:ADBE), ServiceNow Inc. (NYSE:NOW), and Intuit Inc. (NASDAQ:INTU).

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