Goldman Sachs tells clients to bet on these underperforming stocks into earnings

Published Tue, Jul 7 202012:40 PM EDT

(This story is for CNBC Pro subscribers only.) For investors looking to play the second-quarter earnings season, this reporting cycle could be a wild card as the majority of the companies refused to provide guidance, making the disconnect between analysts estimates wider than ever. Goldman Sachs is advising clients to focus on stocks with strong fundamentals that have underperformed the S & P 500 so far this year. That's because the S & P 500 is coming off its best quarter in more than 20 years while earnings took a big hit from the coronavirus crisis. Winning stocks this year would need much better earnings to justify their explosive rally. The bank identified 20 stocks reporting earnings in July with "fundamental upside." The average stock on the list has only performed in line with the S & P 500 over the past month. Goldman used the following criteria to screen these underperformers into the earnings season: Goldman analysts rated "buy" over the next 12 months. Stocks have underperformed the S & P 500 this year. Stocks with at least $5 billion in market cap, to focus on the most liquid names. Stocks where Goldman analysts' earnings-per-share estimate for the upcoming earnings is above consensus estimates. Goldman recommended buying call options ahead of earnings in these names. "Options market positioning on these names is bearish relative to the average S & P 500 stock, implying call prices are attractive," Goldman's derivatives analyst Vishal Vivek said in a note to clients. "Call buying ahead of earnings has consistently returned positive results over the past two decades." Among the list are two banks — Morgan Stanley and Bank of New York Mellon , which are down 5% and 24% this year, respectively. Morgan Stanley posted disappointing first-quarter profit in April and warned its robust trading results may be deteriorating. Two weeks ago, the bank said it performed well enough on the Federal Reserve's most-recent stress test to maintain its current quarterly dividend. Verizon , which is set to report second-quarter earnings on July 24, is also on Goldman's list. The telecom operator had withdrawn its full-year revenue outlook after it lost 68,000 phone subscribers in the first quarter amid lockdowns that closed 70% of its stores. Shares of Verizon are down about 10% this year. Goldman also recommended Kellogg , State Street , Honeywell and Whirlpool .

The Wall Street Bull (The Charging Bull) is seen during Covid-19 pandemic in New York, on May 26, 2020.

Tayfun Coskun | Anadolu Agency via Getty Images

(This story is for CNBC Pro subscribers only.)

For investors looking to play the second-quarter earnings season, this reporting cycle could be a wild card as the majority of the companies refused to provide guidance, making the disconnect between analysts estimates wider than ever.

Goldman Sachs is advising clients to focus on stocks with strong fundamentals that have underperformed the S&P 500 so far this year. That's because the S&P 500 is coming off its best quarter in more than 20 years while earnings took a big hit from the coronavirus crisis. Winning stocks this year would need much better earnings to justify their explosive rally.