Unless you are interested only in investing in micro cap companies I think the best way to screen for ideas is to look in the portfolios of experienced, successful professional money managers. There are several advantages to doing this. One, you immediately get to look at a short list of good ideas. Two, you reduce your chances of making mistakes by having an idea already vetted by an investor you respect. Three, if you are patient and wait for market turbulence to invest your cash chances are you can get into these investments at better prices than the professional manager who wound the idea for you.
I like to take this concept a couple of steps further.
- I focus on the holdings of money managers who invest using a concentrated value style. These managers are risking much larger percentages of their portfolio per position and therefore will have more conviction and better knowledge of each company they invest in. In other words this allows me to look at the very best ideas of investors who can’t afford to make big mistakes given the position sizing they use.
- I try and look for companies that are held by more than one concentrated value investor. If an investment has passed through the due diligence of not one, but two thorough, experienced and successful concentrated value investors the chances of it being a big mistake are even less.
Two of the best and most concentrated value investors of the last fifteen years are Bruce Berkowitz of the Fairholme Fund and Monish Pabrai of Pabrai funds. And one position that they both hold in size is Goldman Sachs (GS).
Berkowtiz has 5% of the Fairholme Fund invested in Goldman. Here is the link to his most recent fund update.
Pabrai is notorious for running a very concentrated portfolio. In the most recent 13F for the Pabrai funds linked below we can see that of the $307 million of stocks Pabrai listed as holding $17 million (5.5%) of that was in Goldman Sachs.
So I’ve established that two investors who typically have most of their funds capital in less than 15 positions think Goldman Sachs is attractive enough to merit an investment in. The question then becomes why?
Value investors typically are contrarian. They look at what nobody else wants hoping to find value. And while I wouldn’t suggest that nobody else wants to invest in Goldman Sachs I would say that the company at this point is almost universally unpopular and that unpopularity has impacted its share price.
Politicians love to show the public that they are tough on Wall Street and Goldman Sachs has become their favorite target. The media couldn’t possibly find a greater evil to portray then the ultra-rich folks and Goldman Sachs and have skewered Goldman relentlessly over the past couple of years. And with all of this government and media attention even most of the general public is aware that Goldman Sachs had a role in creating the enormous housing bubble that has left so many Americans in financial ruin.
While this unpopularity with the press, politicians and public has impacted Goldman’s share price creating a potential opportunity I wonder how much Goldman’s actual business has changed.
Consider the following comment from the recent quarterly letter of Kovitz Investment Group (Kovitz) who recently initiated a position in Goldman and think business isn’t much different:
“Investment companies with large block size positions for sale in a public company are sure to call Goldman for a quote. Corporate execs who want to market their company to would be suitors are surely going to see what Goldman can do for them. And a powerful hedge fund trader or investment banker looking for new surroundings is likely going to consider seeking employment at Goldman Sachs. All of this was true before September 2008, widely viewed as the height of the financial crisis, and remains true today.”
While Kovitz thinks there doesn’t seem to be much impact to Goldman’s business due to reputational damage, the one big change to Goldman Sachs that may impact earnings going forward is the change to a bank holding company. How will the regulations that come with this influence Goldman’s ability to simply go out and make money? Will Goldman be as profitable as a bank holding company as it was previously? Kovitz Investment Group thinks it is too early to tell what this change means, but they bought the stock anyway. Here is why they bought despite uncertainty imposed by the new bank holding company status:
“So then why buy the stock? Basically, because we believe that the current valuation is much too low for this business even with some degree of earnings erosion from the factors mentioned above. At current prices, Goldman Sachs’ stock is trading near book value. At this valuation, a buyer today is paying nothing for the value of the franchise and its earnings power. The only time it traded anywhere near this valuation was late 2008, when going out of business seemed to be a real possibility for all financial companies. Absent such a panic, Goldman Sachs stock should certainly trade near intrinsic value, north of 1.5 times book, in our opinion.
Our estimate of the intrinsic value of Goldman Sachs is based largely on a couple of factors. Goldman has a thriving asset management business and investment banking operation that require minimal amounts of capital. Earnings are being generated for the company without the need of significant capital, leaving most of those earnings for use in its trading businesses. Also, if you remove our estimate of the value of its non-capital intensive businesses from Goldman Sachs’ share price, its remaining business are trading at a price below book value. That is truly amazing. The market is saying that Goldman management will not only fail to generate a satisfactory return on book value, but it will destroy book value. That is hard to believe given the cheap interest rates that Goldman Sachs borrows at, the reputation Goldman enjoys in the business community, the structure of the organization, and the pedigree of its employees. A minimal return on equity of say 12-14% (not high for a financial company given the use of leverage) over the next 5 years would make the company worth far more than it is valued at today.”
So for Kovitz it is simply a matter of the price being too good to ignore despite a lack of clarity on how the business will be impacted by the bank holding company structure. Another issue that an investor likely needs to be concerned with is whether there are any significant legal issues still remaining to be resolved from Goldman’s involvement in housing bubble mortgage related investments gone bad.
And this is where my interest in Goldman as an investment wanes because I have no idea as to just how inappropriate or appropriate Goldman’s actions were or how severe or immaterial any legal consequences of those actions could be. I can’t shake the memory of how Saloman Brothers was almost ruined by the actions of one employee doing stupid things. Why couldn’t there be a skeleton like that hiding the Goldman housing bubble days that we have yet to learn about ?
Actually I think Goldman belongs squarely in my too hard pile even without the legal concerns. The entire company from my vantage point isn’t much more than a black box that spits out earnings. I have no idea what this company will be making ten years from now and I certainly have no ability to understand what my downside risk might be in investing in Goldman. With the leverage involved in this business I don’t get much comfort that book value means much when it comes to a worst case valuation. Book value can quickly become zero for a leveraged company if their assets lose only a small percentage of their value. And I don’t think I could ever get comfortable that I understand what is in the Goldman asset pile.
Goldman Sachs is a pass for me. Not because I think Berkowitz and Pabrai are wrong and that this isn’t a great investment at these prices. But rather simply because I don’t understand the valuation or the business well enough to risk money on it myself.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
