These value stocks will 'catch up' to growth stocks once economy improves, Goldman says

Published Mon, May 18 202011:40 AM EDTUpdated Mon, May 18 202012:15 PM EDT

(This story is for CNBC Pro subscribers only.) Value investing has long gone out of style for many investors after years of underperformance, but Golman Sachs is calling a revival of this classic factor strategy after the historic coronavirus sell-off pushed the valuation dispersion to near record levels. The valuation gap between expensive and cheap stocks is now the widest on record outside of the tech bubble of 1999, according to Goldman's chief U.S. equity strategist, David Kostin. The market's highest flyers have been driving stocks' rebound, setting the stage for cheap names to take the leadership role when the economy growth starts to pick up again, Goldman said. Here are the bank's top value picks. "The extreme current valuation gap between the most expensive and least expensive stocks will most likely be closed when an improving economic environment causes the low valuation stocks to 'catch up' to the current market leaders," Kostin said in a note. Driven by strong comeback in growth stocks, the S & P 500 has rallied more than 30% from its March low despite a severe deterioration in corporate earnings and economic conditions amid the pandemic. The collective top 20% of stocks from every S & P 500 sector are trading at 27 times their earnings, while the bottom 20% of stocks with the same sector trade at a multiple of 9 times, Goldman said. Historically, the strong outperformance by the most expensive stocks usually ends when economic growth improves, Goldman said, based on six similar periods in the last 30 years. "Most of these inflections occurred near the trough of a recession or major economic slowdown," Kostin said. "Similar episodes in the past have generally ended with low valuation stocks 'catching up' to their high valuation peers. Wall Street is growing more hopeful that the economy has bottomed and is on the road to recovery amid states' partial reopenings and positive news about a potential coronavirus vaccine. Goldman screened stocks with a combination of below-average valuations, but also above-average returns on capital. These stocks are poised to catch up fast to growth peers when the economy improves, Goldman says. The graphic above shows where these stocks rank in terms of value. For example, Aflac is among the cheapest 21% of stocks in its sector. "Although these firms carry discounted multiples, most have stronger balance sheets, generate superior returns, and have faster consensus 2019-2021 EPS growth than the median S & P 500 stock," Kostin said. The list includes chipmakers Applied Material and Lam Research , which are both down about 11% this year. Insurance companies Humana and Aflac are have relatively low valuation and promising earnings outlook. Gilead Sciences is also on Goldman's list. While investors have been bidding Gilead shares up on hopes for a possible coronavirus drug, the biotech firm is still not overvalued. The stock is up more than 14% this year. Goldman's value picks also include Best Buy , Oracle , H & R Block and General Dynamics . — CNBC's Michael Bloom contributed reporting.

Johannes Eisele | AFP | Getty Images

(This story is for CNBC Pro subscribers only.)

Value investing has long gone out of style for many investors after years of underperformance, but Golman Sachs is calling a revival of this classic factor strategy after the historic coronavirus sell-off pushed the valuation dispersion to near record levels.

The valuation gap between expensive and cheap stocks is now the widest on record outside of the tech bubble of 1999, according to Goldman's chief U.S. equity strategist, David Kostin. The market's highest flyers have been driving stocks' rebound, setting the stage for cheap names to take the leadership role when the economy growth starts to pick up again, Goldman said.

Here are the bank's top value picks.