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Goldman Sachs (NYSE:GS) somehow has the talent to be in the headlines. And when in the headlines, they are usually negative. As we are still in a phase of (investment) bank bashing, openly displaying contempt for the banking profession and a media bias toward negatively reporting about financial firms, common stocks of banks are still mostly out of favor. The upcoming presidential election in the U.S. could propel the financial crisis and the role of the banks in it back to the center of the political debate. I think it is time to move past that and evaluate those banks for what they are: Important financial institutions that finance growth through lending.

Even though a recent op-ed in the New York Times questioned Goldman Sachs' allegiance to its clients, I have had quite opposite experiences. Based on my experience as an M&A advisor for a Big 4 audit firm, GS had quite a good standing with its clients. Both Bruce Berkowitz and Warren Buffett, two of the most successful and accomplished investors in the world, speak favorably about the company. Which leads me, in effect, to believe that damages from a tarnished reputation are overblown. I almost consider negative news about financial firms as part of a wider, recurring news cycle. The bottom line is, clients of GS are not as dissatisfied and abandoning the firm as some would like you to believe.

According to Yahoo Finance GS currently shows a P/B of 0.86 and JP Morgan (NYSE:JPM) has a P/B of 0.90. Both companies exhibit higher valuations than Bank of America (NYSE:BAC) with a P/B of 0.40 or Citigroup (NYSE:C) with 0.52. The market assigns a higher valuation to both GS and JPM because of their stronger market position and a perceived higher earnings potential. My thesis to buy GS is based on five main reasons. Investors should keep in mind, that I invest only with a long-term focus and do not intend to sell GS until it has reached it full potential: A pre-recession multiple of 2-2.5 on book value in a normalized environment. The following points are supported by GS' Q1 2012 earnings call and accompanying information as well as GS' Credit Suisse 2012 financial services forum (pdf) presentation.

  1. GS has a strong client base. If clients were truly dissatisfied, client issues would surface with greater breadth and intensity and more importantly, from informed and affected client circles, not former disgruntled employees. The franchise GS is intact.
  2. GS is market leader in profitable investment banking and holds the pole position to profit from increased M&A activity once the economy improves.
  3. GS is well capitalized with high Tier 1 capital ratios (Tier 1 capital ratio 14.7% and a Tier 1 common ratio 12.9%) reducing risk and putting the company on a stronger footing on its way into the next expansion.
  4. GS does the right things operationally: It manages liquidity conservatively, has one of the industry's best risk management, creates a leaner operation through cost reduction programs and earns decent ROEs (around 12% annualized based on Q1 2012 numbers) that leaves room for improvement.
  5. As a result of the recent pullback in its stock price, the firm is only valued at a forward P/E of below 8.

Conclusion

For only 8x leading earnings investors can pick up one of the most profitable financial companies. The P/B is currently 0.86 and has traded above two on more than one occasion in the past. I am holding GS over the entire next financial cycle based on the rationale that the book valuation of this industry-leading company will revert back to its normalized range of between 2-2.5.

Source: 5 Reasons To Buy Goldman Sachs