In a week where financial stocks are suffering through an implosion of historical proportions and fear has gripped the investing public, we believe it is reasonable to point to a stock that is a victim of this fear. Goldman Sachs (GS) has done its best to keep its nose clean and has been praised previously for deftly navigating the mortgage and credit problems that have plagued much of the financial sector. It is worth remembering that Goldman—who reported earnings Tuesday, the 16th—was able to post positive earnings last quarter! To be fair, its net plunged 71% but in a market where massive write-downs have triggered stock price gains when the news was not as bad as expected, the sell-off in Goldman shares seems excessive. In this quarter’s very difficult operating environment, I think Goldman management should be proud of the job they have done. However, there is only so much that Goldman can do as the market around it deteriorates.
The market fears that the independent investment bank, as a business model, will not survive the meltdown we are now experiencing. Goldman Sachs and Morgan Stanley (MS) are the only two remaining independent investment banks of any size. Some analysts think that these banks will eventually need to merge with a commercial bank in order to smooth the earnings impact of the capital market’s business cycle.
However, Goldman defends itself by saying that its competitors have struggled so mightily because of a failure to properly manage risk and asset concentration rather than a weakness in the actual business model. We tend to agree with Goldman (although Robert Samuelson makes a strong argument for why Wall Street is collapsing), but whether Goldman is right or wrong may not matter as long as the market continues to pummel its stock into the ground.
Goldman’s stock Wednesday was driven below $100 (for a short time) for the first time since June of 2005. We upgraded Goldman to a Buy rating on September 9th and see little reason to back off of that stance. Now, as we have made clear in previous posts, our ratings should be viewed as an adjective that describes that stock instead of a verb. Allow me to try and put some lipstick on Goldman’s “pig” of a day—to bring some political levity to this post. When one views Goldman in the context of the last 10 years, it was undervalued in the $130’s and is even more so today. For example, Goldman’s Price-to-Sales has historically ranged between 1.08x and 1.74x, but after Wednesday’s decline that number is 1.14x, near the low end of that valuation range. Even more convincing is that Price-to-Cash Flow metric which has historically been between 7.7x and 12.5x and at current levels it is only 5.2x or almost 50% below its average. So while GS’s price direction over the short-term is anything but predictable, we think that management at the company has proven itself highly capable of navigating through a huge crisis and the stock is undervalued at current levels. Is there a clearer example of the market’s irrational trepidation than GS’s more than 25% decline after reporting better- than-expected (and positive) earnings?