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A team of U.S. equity analysts at Goldman Sachs’ says they’ve figured out the secret to U.S. stocks’ long-term outperformance vs. their international peers.
The answer is pretty straightforward: U.S. corporate managers are more adept at squeezing every last cent of return from each dollar of equity investment. The metric is known to business-school types as “return on equity” (ROE) and it’s calculated by dividing a companies’ net income by the value of shareholders’ equity.
U.S. firms have consistently outperformed their international peers in Japan, Europe and the rest of Asia on this metric, according to data published by Goldman’s David Kostin, the investment bank’s chief U.S. equity strategist, and his team.
As of the end of the first quarter, trailing return on equity for S&P 500 index firms in aggregate equaled 20.4%, placing it in the 97th percentile since 1975, but the absolute level of returns isn’t quite as important as the change over the past decade. That’s where the U.S. market really shines: the S&P 500 has expanded its ROE by 480 basis points in that time, compared with a 370 basis-point increase for European stocks included in the Stoxx 600
SXXP,
and 310 basis points for Japanese stocks included in the TOPIX
180460,
“Managements of U.S. publicly-traded companies increased the returns for their shareholders during the past decade by a far greater amount than their counterparts in Europe, Japan, and Asia,” the Goldman Sachs team said.
It’s this elevated rate of expansion that has helped the S&P 500 generate annualized total returns of 7% since 2000, compared with 3% for Japan and 4% for Europe, Goldman said.
Although the Goldman team expects U.S. equity returns to continue to trump their international peers over the long term, a surge in valuations this year has complicated the relative near-term outlook somewhat, the team said.
As U.S. equity prices have ballooned relative to their expected earnings, portfolio managers have been forced to grappled with a concept that Goldman described as “the triumph of hope over experience.”
The team cited the dotcom boom days of the late 1990s as an example.
“The first issue concerns generative Artificial Intelligence (AI) and the degree of disruption that the innovation may cause,” the Goldman team said.
“Investors have confidence that a select few firms will generate super-sized profits while the returns on AI capex initiatives for most other organizations are less clear.”
“The Dot Com experience of the late 1990s is worth remembering because some Telecom companies that spent mightily to install miles of dark fiber never generated a return sufficient to cover their cost of capital.”
Since AI related stocks have contributed the bulk of this year’s multiple expansion, Goldman said they expect the S&P 500 to deviate from its historical pattern and underperform over the next 12 months.
“High starting valuation is often viewed as an impediment to strong forward returns, and indeed our 12-month global equity forecasts suggest the US will lag other regions…But relentless management focus on boosting ROE suggests over time US stocks should outperform global peers,” the Goldman team said.
U.S. stocks are kicking off August in the red Tuesday, with the S&P 500
SPX,
down 0.2% at 4,579, while the Nasdaq Composite
COMP,
is off by 0.5% at 14,269.
Meanwhile, the Dow Jones Industrial Average
DJIA,
is outperforming, having gained 72 points, or 0.2%, to 35,634 during the first half hour of U.S. trading.
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