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Corporate profitability has likely bottomed in this tough economy, but don’t expect companies to expand margins and profits significantly in the next 12 months, a Goldman Sachs’ analysis shows. Goldman looked at return on equity, which measures net income divided by shareholders’ equity. In general, this ratio measures how well management is squeezing profits out of a company’s assets. Broadly, return on equity increased slightly in the first quarter after declining for four straight quarters, “reflecting a better-than-feared 1Q earnings season and aligning with our view that the worst of the profit margin reset is likely behind us,” David Kostin, chief U.S. equity strategist for Goldman, wrote in a recent note. “Looking forward, although S & P 500 ROE has potentially troughed, substantial ROE growth appears unlikely in the near term. The near-term path of S & P 500 ROE will primarily depend on the path of margins.” Goldman cited the slowing pace of price hikes and higher interest rates and taxes as headwinds for corporate profitability in the short term. But the firm found stocks for clients to buy that are bucking the trend. Goldman looked at companies where its own analysts expect ROE to expand the most over the next 12 months. The stocks in its “ROE Growth Basket” are expected to increase ROE by a median 13% over the next 12 months, compared to a median 9% decline expected in the S & P 500. Here are some of the stocks in the basket: Disney will increase ROE by 21% over the next 12 months, Goldman expects. Meta Platforms is a new member of the basket as of the latest rebalancing. Goldman sees an 8% ROE expansion for the Facebook and Instagram parent that’s undergoing strenuous cost cuts. Over the long term, Goldman believes a new phenomenon could help get overall profits growing again: artificial intelligence. “Widespread adoption of AI by companies could lift productivity across the economy and lead to greater earnings than we assume in our baseline forecast,” stated the note.
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