As investors face rocky financial markets, Goldman Sachs suggests "margin of safety" stocks that it says are too cheap to ignore. U.S. stocks have been under pressure this year amid persistent inflation, the Federal Reserve's rate-hiking cycle , recession risks, the war in Ukraine and global Covid outbreaks. The S & P 500 is down more than 16% this year. "The US equity market has been roiled by a series of macroeconomic headwinds since the start of the year," Goldman chief equity strategist David Kostin said in a note Monday. Given the environment, Goldman recommends a "margin of safety" approach to clients — a classic value investing strategy popularized by the likes of Warren Buffett and Seth Klarman. The "margin of safety" principle generally refers to finding stocks whose market price is significantly below their actual value. Investors like Buffett look for shares that are so cheap the trade works even if earnings do not fully pan out in an uncertain economic environment. Other investors define "margin of safety" as companies with high gross margins that make them more defensive and resilient even if the economy slows or enters a recession. To identify stocks with defensive qualities and a solid margin of safety, Goldman screened the S & P 500 for companies with three key characteristics: size and liquidity, balance sheet strength and attractive valuation. First, Goldman picked out companies with a market cap above $10 billion, using above-average equity capitalization as a proxy for liquidity. Then it looked for stocks with strong balance sheets, using the Altman Z-score, a grading tool developed to forecast bankruptcies. It measures five financial ratios — capital to assets, retained earnings to assets, operating income to assets, leverage ratio and sales to assets. Finally, Goldman analysts identified stocks that have a "margin of safety" at their current valuations. The firm chose stocks with valuations that would still be attractive versus previous bear markets, even if earnings-per-share estimates for 2023 are chopped by 20%. The median "margin of safety stock" has outperformed the S & P 500 this year, according to Goldman. An equal-weighted basket of these shares has also beaten the equal-weighted S & P 500 since mid-2021, the firm said. Take a look at ten stocks on Goldman's list. Energy stocks feature prominently on the list, and they're leading the market this year, up nearly 50% as a group in 2022. Energy companies have benefited from rising oil and gas prices as global economic activity revived after Covid lockdowns, and as sanctions against Russia crimp global supply. Chevron , Exxon Mobil and Devon Energy are among the energy stocks on Goldman's "margin of safety" list. Several semiconductor stocks also appear on Goldman's list. Qualcomm and Micron Technology are two chip names with a margin of safety, Goldman wrote. More typical defensive stocks — consumer staples and health care — on the list include Tyson Foods and Vertex Pharmaceuticals . — CNBC's Michael Bloom contributed to this report.
