- David Kostin of Goldman Sachs is using his high-growth “Rule of Ten” method to help identify stocks that could lead the way Big Tech does today.
- He names 21 companies that are posting much stronger revenue growth than the broader S&P 500 index and are expected to sustain that performance through 2022.
- Kostin further narrows that down to five companies that could one day rival Apple, Amazon, Microsoft, Facebook, and Alphabet in size.
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These days it’s hard to picture a stock market that isn’t dominated by Big Tech. But two decades ago, who imagined a market where GE and Exxon were almost afterthoughts?
The amount of money invested in Apple, Amazon, Microsoft, Alphabet, and Facebook today is staggering, as Goldman Sachs Chief US Equity Strategist David Kostin says the stock market hasn’t been this top-heavy in 40 years. But it will change one day, and Kostin says people are hungry for the next big thing.
“Investors are increasingly searching for fast-growing firms beyond the ‘current five,'” he wrote.
Finding those potential replacements starts with a focus on the incredible growth that made those five companies so successful.
“The ability of these firms to grow sales rapidly regardless of the economic situation has been brought into focus by the corona crisis,” he said. “Growth is particularly important with interest rates at the lower bound. “
So Kostin and his team applied their “Rule of Ten” framework and sought companies that reported annual revenue growth of at least 10% in 2018 and 2019, and are expected to maintain that level in 2021 and 2022. They also have to maintain compound annual sales growth of at least 10% across the five-year period.
Past versions of the rule had an earnings component, but they’re omitting that this time around to focus on revenues. There are 21 S&P 500 stocks that meet Kostin’s guidelines, and their revenue and performance are much stronger than the index as a whole.
“The median stock has expected 2018-2022 annualized sales growth of 18% (vs. 4% for the S&P 500) … and has returned 21% YTD (vs. 0%),” he wrote in a note to clients.
That’s 18% figure is close to the collective 22% revenue growth expected for the FAAMG five over the same period.
A few themes emerge from the new list. Kostin names them as “computerization of healthcare,” “digital transformation of business,” “workflow automation,” and “e-commerce and digital payments.”
But if 21 still seems like a lot compared to just five Big Tech leaders, the Goldman group further narrows their list to what Kostin calls the “future five:” robotic surgery system maker Intuitive Surgical, design software company Autodesk, cloud-based business software maker ServiceNow, payments giant PayPal, and rare disease drugmaker Vertex Pharmaceuticals.
All five benefit from “Large total addressable markets and high barriers to entry,” he said.
Collectively they are projected to post 20% annual sales growth from 2018-22, which is even closer to FAAMG’s results. And they’ve offered similar returns as well: If the stocks are treated as an equal-weight group, they’ve returned 38% to investors this year, compared to 39% for Big Tech.
It’s far from a guarantee that those companies will join Apple and Amazon’s ranks; Wall Street currently values four of the five at less than $100 billion. PayPal is the biggest of the future five, and its market capitalization is just a third of Facebook’s and a little more than a tenth of Apple’s.
But Kostin says the trends that helped make the FAAMG stocks so gigantic will remain in force for years to come, and that at least opens the door for those five companies to become future leaders.
“We believe the market will continue to allocate an exceptionally large premium to growth stocks for the next several years,” he said. “In absolute terms, stocks are highly valued on both an aggregate and median basis. However, stocks are modestly undervalued on a relative basis vs. interest rates.”
Kostin’s 21 stocks are ranked from lowest to highest based on their expected compound annual revenue growth over the five years spanning 2018 to 2022.