Buying a stock is, essentially, buying a share of a company’s earnings, and growth in those earnings is ultimately what drives the stock market. But at any given time, for various reasons, investors are willing to pay more or less for each dollar of corporate earnings, as reflected in the price-earnings ratio, the popular valuation measure for stocks.
Lately, investors have been willing to pay ever-higher prices for their slice of corporate profits, pushing P/Es beyond their historical norms. Based on estimated earnings for the 12 months ahead, the P/E for the S&P 500 was recently 20.3, according to FactSet Research Systems, a financial data firm. That’s greater than both the five-year average of 19.2 and the 10-year average of 17.8.
“In the last year, the rise in stock prices was essentially all due to multiple expansion,” says LizAnn Sonders , chief investment strategist at Charles Schwab. “The market is expensive. No doubt about it,” Sonders says.
If history is any guide, stock prices will fall — or corporate earnings will rise — enough to bring P/Es back into their traditional ranges. Further expansion of P/E multiples could be constrained in coming months, say strategists, as a delay in interest rate cuts from the Federal Reserve and economic uncertainties weigh on stocks. That makes earnings growth all the more important.
Given the market’s crosscurrents, it’s time for long-term investors to make sure their portfolios are buttressed with companies that thrive even in difficult environments.
Growth at a reasonable price
The companies best positioned to deliver gains to long-term investors will be reasonably priced stocks that have proved they can deliver steady, compounding earnings growth and are on track to do so even if the economy softens. “We are now at a point, due to rich valuations, when you want to look for both growth and value, for high-quality companies with stability and the ability to grow earnings,” Sonders says. She notes that many analysts have dubbed this strategy “GARP,” or growth at a reasonable price.
Analysts at Goldman Sachs recently sorted stocks into baskets that included companies that the firm deems “stable growers,” as well as those considered “high quality.” “Earnings drive stocks ... and stocks with stable growth typically perform best alongside decelerating economic growth,” Goldman Sachs chief U.S. equity strategist David Kostin said in a recent note to clients.
We used Goldman’s baskets as a starting point and spoke with other analysts and portfolio managers to find stocks with a good chance of delivering earnings and stock gains. The stocks below have records of steady profit growth, as well as healthy balance sheets or a niche that insulates them in uncertain times. Prices and other data are as of May 31, unless otherwise noted.
American Water Works ( AWK , $131). The country’s largest publicly traded water utility has more than doubled its earnings per share since 2017 and is favored by analysts as a steady earner. Kristina Ruggeri , a water and utility analyst for stock research firm Argus, expects American Water Works to continue increasing its annual earnings per share by 7% to 9% for the foreseeable future, thanks to utility rate hikes, federal infrastructure spending and growing demand from artificial intelligence companies for water to cool their data centers.
At 24 times expected earnings, the stock is trading near the bottom of its historical range over the past five years, Ruggeri notes. In addition, the company recently raised its dividend by 8%. The stock’s yield is an attractive 2.3%.
Water utilities have generally been viewed as long-term holdings because it can take years to recoup outlays for capital improvements and to apply for rate hikes from local regulators. Ruggeri has set a 12-month target price for the stock of $150 per share, suggesting a gain of as much as 20% from its recent close. As one of the largest companies selling a life necessity, American Water “is in a really good position,” she says.
AutoZone ( AZO , $2,770). This auto parts retailer has reported consistently increasing earnings per share for the past decade: from $31.57 in 2014 to $132.36 in fiscal 2023 (which ends in August). Analysts covering the stock expect the company’s earnings to increase at an average annual rate of nearly 15% over the next three to five years, according to S&P Global Market Intelligence. Their average target price for the stock is $3,203, indicating room for a 16% gain over the next 12 to 18 months.
Robert Klaber , a portfolio manager of the Parnassus Mid Cap Growth Fund, says auto parts companies are generally a safe bet no matter what happens to the economy because in good times and bad, people need to repair their cars. The demand for parts will continue to grow because the average U.S. vehicle age this year hit a record high of 12.6 years.
Klaber is optimistic about AutoZone’s expansion plans, including new stores in the U.S., Mexico and Brazil. And he says the stock price has been buoyed because the company has bought back so much stock that its share count has fallen in half over the past 18 years. AutoZone trades at what he considers to be a reasonable P/E of 17. “AutoZone is a defensive earnings compounder with pricing power that is selling necessities,” he says (instead of selling discretionary goods that people can easily forgo).
CDW ( CDW , $224). This technology middleman avoids many of the swings of the tech boom-and-bust cycle because it focuses on selling bundles of computers and software made by other companies to government agencies and businesses. In the 10 years ending in December 2022, its earnings rose steadily, from $1.83 a share to $9.88. But last year’s earnings were essentially flat, in part because a threat of a federal shutdown delayed orders; the company was still in catch-up mode in early 2024.
Still, seven out of the 11 Wall Street analysts following the company are bullish on the stock, and Samik Chatterjee, an analyst at J.P. Morgan, calls CDW “historically a favorite, given its resilience in a volatile backdrop.” He projects earnings per share to rise by 4% in 2024 and nearly 12% in 2025. Noting that the stock is trading at a reasonable P/E of 21, Chatterjee has set a target of $265 for the stock in 2024, implying a potential 18% gain from the stock’s recent close.
ResMed ( RMD , $206). The world’s largest manufacturer of breathing devices for people with conditions such as sleep apnea has reported increasing earnings over the past six years, except for a blip in 2021 due in part to COVID-related computer chip shortages and shipping delays. Earnings per share rose from $3.53 in 2018 to $6.44 in 2023. Ten out of the 15 analysts who follow the company are bullish, according to S&P. Zacks Investment Research classifies the stock as an outperformer and expects earnings per share to rise by about 13% in 2024 and by that much again in 2025.
Shane Ponraj , who follows ResMed for the research firm Morningstar, considers the stock a good bet because its continuous positive airway pressure (CPAP) devices help reduce health emergencies for people who have trouble breathing while asleep, thus reducing medical costs in the long run. Ponraj estimates that up to 15% of the developed world’s population could benefit from CPAPs, but only 3% use them. That “indicates a long runway for growth,” he says. Adding to the company’s strength: Its main competitor, Phillips, had to recall millions of CPAPs in 2021 because of problems with insulation inside their devices.
Although ResMed was recently trading at nearly 25 times next year’s earnings, Ponraj and other analysts expect the earnings growth to push the stock price ahead. Ponraj estimates the company would be fairly valued at $264, implying a 28% potential gain.
Waste Management ( WM , $211). There are only 26 stocks in Jensen Quality Growth fund, and Waste Management is one of them. Comanager Allen Bond thinks the nation’s largest waste hauler can profit in any kind of economy. No matter what happens, people need to get rid of their garbage. And the company’s investments in improvements such as automated sorting at recycling facilities are strengthening its revenues and profits, he says.
Since 2020, Waste Management has increased earnings per share by a cumulative total of 54%. Deutsche Bank analyst Faiza Alwy expects the firm to log double-digit annual earnings growth at least through 2025.
Waste Management stock has posted healthy annualized returns of nearly 16% over the past five years. It recently traded at 28 times expected earnings for the next 12 months. That makes the stock higher priced than the broad market, as measured by the S&P 500. But because of its track record of resilience during downturns and its outlook for growth, Waste
Management meets the Jensen fund’s criteria for growth at a reasonable (not necessarily a bargain) price. “We are not looking for deep values. We are looking for quality at a reasonable price,” Bond says. One quality he especially likes: The company’s return on equity of 35% is about double that of the broader market. Return on equity is a profitability yardstick that measures how well a company generates profits from shareholders’ investments — which is, after all, the name of the game.
Note: This item first appeared in Kiplinger Personal Finance Magazine, a monthly, trustworthy source of advice and guidance. Subscribe to help you make more money and keep more of the money you make here .
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