ProPublica Wrong on Break Up Advice to Goldman

Jan.20.11 | About: Goldman Sachs (GS)

A column in today's New York Times appears under the headline "Goldman Sachs's (NYSE:GS) Navel-Gazing Comes Up Short." The column, provided by the non-profit news organization ProPublica, criticizes Goldman Sachs and advises the firm to break itself up into smaller pieces:

Despite Goldman's reputation in some corners as Evil Genius, its shares are actually suffering in the marketplace because investors worry about its volatile and unpredictable results from quarter to quarter. These concerns were validated when Goldman reported on Wednesday that trading and securities services profit took a big hit in the fourth quarter, dropping 31 percent. The stock slid 3 percent by midafternoon in response.

Investors prefer annuities to swing-for-the-fences profits. Compared with pure asset managers and investment banks that specialize in either advisory work or making markets, Goldman stock trades at a discount these days. Goldman's price-to-earnings ratio stands at less than 10, while Lazard (NYSE:LAZ) (a pure advisory firm), Jefferies (JEF) (a market maker) and BlackRock (BLF) (an asset manager) trade at significantly higher multiples.

This analysis strikes me as flawed in several respects.

First, the assertion that Goldman shares are "suffering in the marketplace" is questionable when you look at it over a longer period than from Wednesday morning to "midafternoon." Goldman shares have gone from a low of about $53 in November 2008 to about $166 today, more than tripling in value. If that's "suffering," sign me up.

Second, the assertion that investors worry about volatility and "prefer annuities to swing for the fences profits." This may be an accurate statement in terms of psychology or behavioral economics, but a smart investor with an eye on long-term wealth accumulation might want to accept some of the extra volatility in the hopes of achieving better long-run returns. Why should Goldman Sachs have to break itself up just because some investors have an irrational aversion to volatility or a short-term time horizon? If you took this argument to its logical conclusion, there wouldn't be stock market investing at all, just annuities or CDs.

Third, Lazard isn't a "pure advisory firm"; it does asset management, too. And Jefferies isn't only a market maker, it does asset management and advisory, too.

Fourth, the comparisons between Goldman and Lazard, Jefferies, and Blackrock don't necessarily support the column's argument. Goldman's market capitalization is about $84 billion, while Lazard's is about $4.6 billion and Jefferies' is about $5.3 billion. The Times column looks at price-earnings multiple, but it doesn't mention market capitalization. Goldman shares have more than tripled from their November 2008 low, Jefferies shares have about tripled from their March 2009 low, and Lazard shares have almost doubled from their March 2009 low, so in terms of price appreciation, Goldman is hardly lagging. One could take the same set of facts and argue that Jefferies or Lazard are overpriced or that Goldman shares will eventually rise.