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Companies with the strongest balance sheets are in the best position to weather the cash-ﬂow shock resulting from the economic shutdown, but some of these stocks are picked over and trading at sky-high valuations, according to Goldman Sachs.
For this reason, the Wall Street firm created a "quality-at-a-reasonable-price" basket for its clients to find stocks with strong balance sheets and reasonable valuations. Goldman believes the group of stocks will outperform the broader market this year thanks to the coronavirus pandemic.
Goldman's list identifies a handful of stocks that rank in the top 20% of balance sheet strength within their sector, but do not carry top or bottom-place valuations.
"We exclude stocks that rank in the top 20% of valuations in their sectors. To avoid "value traps" or ﬁrms with secular headwinds that might not be otherwise captured in the screen, we also exclude stocks ranking in the bottom 20% of their sectors on valuations," Goldman analyst Arjun Menon said in a note to clients.
The Wall Street firm gauges balance sheets strength using the Altman Z-score, which assesses working capital, earnings, EBIT, market value and sales to figure the likelihood of the company defaulting. To gauge valuation, Goldman uses price to 2021 earnings ratio, given the firm expects substantial revisions to consensus 2020 estimates as the impact of the economic shutdown becomes more clear.
CNBC put together a list of 10 stocks from Goldman's list. Take a look here.