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Goldman Sachs (NYSE:GS) is perhaps the most hated company in America. Public disdain for investment bankers has made GS the poster child for populists and "the 99%" movement alike. Shares have bounced strongly from their year lows of $90 to trade at $145 currently. With the worst of the financial crisis behind the bank and public disdain for investment bankers growing by the second, what's next for GS shares? This article will take a look at GS's estimated fair value based upon its future earnings and dividends.

To do this, we'll use a DCF-type approach that requires some assumptions: 1) discount rate of 10% 2) dividend growth rate of 7% per annum 3) perpetual growth rate of 3% 4) earnings estimates from Yahoo! Finance. I have used what I consider to be reasonable estimates; you may disagree with some or all of my numbers but keep in mind all forecasting is subject to conjecture and risk.

2013

2014

2015

2016

2017

2018

Earnings Forecast

Reported earnings per share

$14.36

$15.24

$16.25

$17.33

$18.48

x(1+Forecasted earnings growth)

6.15%

6.63%

6.63%

6.63%

6.63%

Forecasted earnings per share

$14.36

$15.24

$16.25

$17.33

$18.48

$19.71

Equity Book Value Forecasts

Equity book value at beginning of year

$138.62

$150.84

$163.79

$177.60

$192.31

$207.98

Earnings per share

$14.36

$15.24

$16.25

$17.33

$18.48

$19.71

-Dividends per share

$2.00

$2.14

$2.29

$2.45

$2.62

$2.81

$3.00

Equity book value at end of year

$138.62

$150.84

$163.79

$177.60

$192.31

$207.98

$224.69

x Equity cost of capital

10.00%

10.00%

10.00%

10.00%

10.00%

10.00%

Normal earnings

$15.08

$16.38

$17.76

$19.23

$20.80

$22.47

Forecasted EPS

$14.36

$15.24

$16.25

$17.33

$18.48

$19.71

-Normal earnings

$15.08

$16.38

$17.76

$19.23

$20.80

$22.47

Abnormal earnings

-$0.72

-$1.14

-$1.51

-$1.90

-$2.32

-$2.76

x discount factor (10%)

0.909

0.826

0.751

0.683

0.621

0.564

Abnormal earnings disc to present

-$0.66

-$0.94

-$1.13

-$1.30

-$1.44

-$1.56

Abnormal earnings in year +6

($1.56)

Assumed long-term growth rate

3.00%

Value of terminal year

($53.50)

Estimated share price

Sum of discounted AE over horizon

($7.02)

+PV of terminal year AE

($30.17)

PV of all AE

-$37.20

+Current equity book value

$138.62

Estimated Current share price

$101.42

Given my assumptions, GS has an approximate fair value of $101.42 per share currently. Knowing that shares are trading about 50 percent higher than that amount at the time of this writing, shares look like a disaster waiting to happen. Before you commence panic selling the shares, we need to understand what this number means.

First, it's important to understand what this fair value calculation really means. It implies that discounting GS's earnings at 10% to compensate for the time value of money and the risk that the company will not achieve its targets nets a fair value far below the current trading price. This means that with a relatively high bar to clear with a 10% discount rate, shares are terribly overvalued. In essence, the fair value price is the price at which the company is still a good buy given your discount rate. As GS is trading nearly 50% above that amount, it is rejected on that basis.

Second, the $101.42 is not the forecasted nominal price six years from now. Rather, it is the net present value of the company's forecasted earnings at a 10% discount rate. Given the company's current forward PE of 9.6, shares would be trading at roughly $189 in 2018 if the forward PE remains the same and GS achieves earnings of $19.71 per share. In other words, the stock could move up about $40 in six years.

Lastly, if you look at the "Dividends per share" line in my model, you'll see that I'm forecasting GS will only pay about $15.31 per share in cumulative cash dividends from 2013 to 2018. That implies you've only got roughly 10% of the current share price headed your way in cash distributions over the next few years given my assumptions about cash dividends. Of course, nobody can forecast what GS's dividends will look like for the next 6 years, but I have provided what I believe to be reasonable assumptions about the company's ability to generate cash and distribute it to shareholders. GS isn't known for distributing large dividends; rather, the perception (and probably reality) is that management is more interested in paying its employees. Therefore, GS's dividend is quite unsubstantial. There is nothing inherently wrong with this practice but as a shareholder, you should adjust your expectations.

There are risks to my forecasts, however, as GS may grow earnings much more quickly than analysts are currently forecasting. While 6.6% earnings growth is pretty modest, given the increased regulatory scrutiny investment banking is subject to and public disdain for virtually any profit-oriented company, I don't see how GS can stay as profitable in its current lines of business as it is. I have great confidence that there is enough support from our "leaders" in Congress to make it progressively more difficult for GS and others to make money in the trading, M&A, advisory and other lines of business. Since these businesses comprise nearly all of GS's work, it is at great risk, in my view, due to new legislation and the whims of Congress.

Given this information, I believe investors should avoid Goldman Sachs right now. I pegged the fair value of shares today at around $100; with shares trading at a 50% premium to that number, there is no way I could justify a long position. In fact, in order to understand what is being priced in right now, we can adjust the model's earnings expectations to reflect a fair value equal to the current price.

2013

2014

2015

2016

2017

2018

Earnings Forecast

Reported earnings per share

$14.36

$16.03

$17.88

$19.96

$22.27

x(1+Forecasted earnings growth)

11.60%

11.60%

11.60%

11.60%

11.60%

Forecasted earnings per share

$14.36

$16.03

$17.88

$19.96

$22.27

$24.86

Equity Book Value Forecasts

Equity book value at beginning of year

$138.62

$150.84

$164.58

$180.01

$197.35

$216.82

Earnings per share

$14.36

$16.03

$17.88

$19.96

$22.27

$24.86

-Dividends per share

$2.00

$2.14

$2.29

$2.45

$2.62

$2.81

$3.00

Equity book value at end of year

$138.62

$150.84

$164.58

$180.01

$197.35

$216.82

$238.68

x Equity cost of capital

10.00%

10.00%

10.00%

10.00%

10.00%

10.00%

Normal earnings

$15.08

$16.46

$18.00

$19.73

$21.68

$23.87

Forecasted EPS

$14.36

$16.03

$17.88

$19.96

$22.27

$24.86

-Normal earnings

$15.08

$16.46

$18.00

$19.73

$21.68

$23.87

Abnormal earnings

-$0.72

-$0.43

-$0.12

$0.22

$0.59

$0.99

x discount factor (10%)

0.909

0.826

0.751

0.683

0.621

0.564

Abnormal earnings disc to present

-$0.66

-$0.36

-$0.09

$0.15

$0.37

$0.56

Abnormal earnings in year +6

$0.56

Assumed long-term growth rate

3.00%

Value of terminal year

$19.19

Estimated share price

Sum of discounted AE over horizon

($0.02)

+PV of terminal year AE

$10.82

PV of all AE

$10.80

+Current equity book value

$138.62

Estimated Current share price

$149.42

GS shares are currently pricing in 11.6% earnings growth through 2018, all else is equal with my model's assumptions outlined previously. If you think GS will earn nearly $25 in 2018, the shares are probably a decent bet at this point. However, that assumes no downside margin of safety to the forecast as GS must attain nearly double its projected rate of earnings growth to achieve that earnings number. If you think this will happen and there is nearly 100% upside to the consensus earnings growth rate, GS shares can be bought today. If you are like me and you find that to be a bit hard to take, GS shares are an "avoid" for most investors and a short candidate for more aggressive investors.

Source: Why You Should Short Goldman Sachs