Reggie Middleton vs Goldman Sachs, Round 2

By: Reggie Middleton | Mon, Feb 1, 2010
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Before I get started, I want all to realize that this is not Goldman bashing piece. I think it is a [relatively] well run company, but its PR machine appears to be from Kindergarten land, and the aura of invincibility that it enjoys(ed?) is highly undeserved, as a consequence its historical "aura-based" premium is absolutely unjustified. Case in point...

On December 8th of last year, I penned "Reggie Middleton vs Goldman Sachs, Round 1" wherein I challenged all to take a critical look at exactly how much money was lost by Goldman Sachs' clients. Well, here comes round 2, which is directed at Goldman (over)valuation.

Three months ago I explicitly warned my readers and subscribers about how outrageously priced Goldman Sachs was: Get Your Federally Insured Hedge Fund Here, Twice the Price Sale Going on Now! Monday, 19 October 2009. Goldman was closed at $186.10 that day.

Although GS' had beaten street expectations (which everyone at BoomBustblog.com should recognized as the game that it is), the company's share price has significantly run ahead off its fundamentals. Since December 2008, the company's tangible book value per share has increased by a modest 3.2% while its share price has increased by a whopping 92.1% with its Price-to-Tangible Book value per share ratio currently standing at 1.77x compared with 1.45x in 2Q09 and 0.45x in 4Q08. Based on closing price as of October 18, 2009, GS' price-to-tangible book value per share is at 1.99x while average price-to-tangible book value per of its peers stood is 1.55x, implying a premium of 28% for the Goldman Sachs brand name. As I said, an expensive, federally insured, publicly traded hedge fund with a strong lobby arm and an even stronger brand management department.

Readers should take into consideration that this is the exact same argument that I posed a year and a half ago when I first shorted Goldman Sachs at $185! Where is it trading today? $186.43. This is after it had to be rescued by the government for fear of collapse!

Let's revisit history with an excerpt from Goldman Sachs Snapshot: Risk vs. Reward vs. Reputations on the Street Saturday, 05 July 2008, it's deja vu all over again...

I rode Goldman down to the $100 to $75 band, but it eventually bottomed somewhere around $50. Now it's right back where it started from, pre-bailout. Does it deserve to be there??? Inquiring minds want to know...

I consequently wrote "It appears as if the patina on Goldman's Stock is fading..." wherein I stated on the 15th of December (Goldman traded at $162.70):

"The amount of public resentment, potential for political backlash (yes, even Goldman can get stabbed in the back when a sacrificial lamb is needed), surfacing compensation issues (remember, on the Street, compensation is everything - there really is no company loyalty) and unwarranted premium added to this company's share price over the last few quarters appear to be culminating into another potential collapse in the company's share price. This is not investment advice, simply an anecdotal opinion.

I believe the Goldman premium will be reduced, along with its transient above market earnings potential/advantage (when the edge that it has is assimilated into the market). It probably cannot maintain its trading record for more than a few quarters (98% profitable days of trading out of a month is statistically impossible, but that is a story for another day), and its other value drivers still don' t look very promising. Last but not least, there is the matter of all of that trash still on the balance sheet. If the market's euphoric bear rally breaks, which it looks like it may (finally), then Goldman will break along with it. It has a long way to fall if it does."

Well, here we are on Jan 30th, 2010. Goldman's last closing price was $148.72, down 20% and primed to test their 52 week lows. Let's take a closer look at Goldman's last quarter then remind subscribers why they pay for my services. After all, just like in 2008, not one was talking about shorting the indestructible, government protected, almighty, infallible, uber-bailed out Goldman at their highs besides me (twice).

Reggie on Goldman's Q4 2009

My blog subscribers can download the full quarterly review and opinio here: This reveiew has an updated valuation componet for Goldman, takng into consideration what we feel the stock is worth now, and also what could potentially happen if the market continues to slide further and signficantly. See GS 4Q09 Final Review and Updated Valuation 2010-02-01 03:04:55 528.52 Kb

Non-subscribers (which, you all should be subscribers, but I'll forgive you for now), take note of this excerpt and screen shot from the subscription report.

With trading revenues dictating the overall profitability of investment banks like Goldman Sachs, important concerns are being raised about the business models of investment banks which are highly dependent on the trading income (highly volatile under current conditions) to sustain their profitability. Trading revenues (nearly 64% of the total net revenues in FY09) form a substantial portion of Goldman's revenue stream and movements in this income stream determines the Company's total revenues overall profitability. In 2009, trading revenues amount to nearly 63.9% of the total net revenues while the impact on earnings is magnified with the total trading revenues amounting to 145.6% of the total pre-tax income.

Comparing with the peers, the trading revenues accounts for highest percentage of total revenues in case of GS. The Company's trading revenues are largely driven by the activity levels as well as spreads, both of which are market determined and decided by general macro-economic conditions. With nothing more uncertain than the macro-economic conditions and markets in US, this income stream is becoming increasingly volatile under the current circumstances. The future sustainability of this income is further dented by Obama's recent policy announcements to curb proprietary trading (trading with no client related transaction involved and primarily done to earn profits by assuming greater trading risk). The administration is working out increased restriction on the risk-taking involved in earning prop trading revenues. The government is also planning to put restrictions on hedge funds and private equity transactions which will directly impact the revenues from Principal Investments of Goldman Sachs. Thus, apart from the risk of regulatory move that can seriously clamp down the trading revenues, the risk of deterioration in the general market condition, increase in volatility or a serious dislocation like the one witnessed in 2008 seriously undermine the future profitability of GS.

This multiple summary and graphs above also explains how Obama effectively cut the compensation GS, and to the lesser extent, othe banks employees. They are getting stock at the peak of a banking bubble - particularly after the most recent run up. I know I have heard pundits and analysts across the media saying that employees are getting discounted stock, but it is stock discounted off of a bubble at a time when banks are about to become worth a lot less - that is unless they find a way to do something else that is very productive contributory to growth (other than theirs) to replace extant yet dwindling revenue streams. Just take a look at the facts and figures above. They don't lie!

So, what is GS if you strip it of its government protected, name branded hedge fund status. Well, my subscribers already know. Let' take a peak into one of their subscription documents (Goldman Sachs Stress Test Professional 2009-04-20 10:06:45 4.04 Mb - 131 pages). I believe many with short term memory actually forgot what got this bank into trouble in the first place, and exactly how it created the perception that it got out of trouble. The (Off) Balance Sheet!!!

Contrary to popular belief, it does not appear that Goldman is a superior risk manager as compared to the rest of the Street. They may the same mistakes and had to accept the same bailouts. They are apparently well connected though, because they have one of the riskiest balance sheet compositions around yet managed to get themselves insured and protected by the FDIC like a real bank. This bank's portfolio looked quite scary at the height of the bubble.

You know what most people don't realize is that it looks quite scary now as well.

If one were to strip out the revenues from prop trading, it would leave bards some balance sheet issue. Again, I query, should virtual hedge funds that pay out half of revenue as compensation trade at such high premiums to the rest of the market? I don't think so, and I have put my money behind the idea that the market will not think so in the near future either.

More of Reggie on Goldman Sachs


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Goldman Sachs Stress Test Retail 2009-04-20 10:08:06 720.25 Kb - 17 pages
Goldman Sachs Stress Test Professional 2009-04-20 10:06:45 4.04 Mb - 131 pages

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Reggie Middleton

Author: Reggie Middleton

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Reggie Middleton

Who am I?

Well, I fancy myself the personification of the free thinking maverick, the ultimate non-conformist as it applies to investment and analysis. I am definitively outside the box - not your typical or stereotypical Wall Street investor. I work out of my home, not a Manhattan office. I build my own technology and perform my own research - in lieu of buying it or following the crowd. I create and follow my own macro strategies and am by definition, a contrarian to the nth degree.

Since I use my research as a tool for my own investing to actually put food on my table, I can stand behind it as doing what it is supposed too - educate, illustrate and elucidate. I do not sell advice, I am not a reporter hence do not sell stories, and I do not sell research. I am an entrepreneur who exists just outside of mainstream corporate America and Wall Street. This allows me freedom to do things that many can not. For instance, I pride myself on developing some of the highest quality research available, regardless of price. No conflicts of interest, no corporate politics, no special favors. Just the hard truth as I have found it - and believe me, my team and I do find it! I welcome any and all to peruse my blog, use my custom hacked collaborative social tools, read the articles, download the files, and make a critical comparison of the opinion referencing the situation at hand and the time stamp on the blog post to the reality both at the time of the post and the present. Hopefully, you will be as impressed with the Boom Bust as I am and our constituency.

I pay for significant information and data, and am well aware of the value of quality research. I find most currently available research lacking, in both quality and quantity. The reason why I had to create my own research staff was due to my dissatisfaction with what was currently available - to both individuals and institutions.

So here I am, creating my own research for my own investment activity. What really sets my actions apart is that I offer much of what I produce to the public without charge - free to distribute and redistribute, as long as it is left unaltered and full attribution is given to the author and owner. Why would I do such a thing when others easily charge 5 and 6 digits annually for what some may consider a lesser product? It is akin to open source analysis! My ideas and implementations are actually improved and fine tuned when bounced off of the collective intellect of the many, in lieu of that of the few - no matter how smart those few may believe themselves to be.

Very recently, I have started charging for the forensics portion of my work, which has freed up the resources to develop the site to deliver even more research for free, particularly on the global macro and opinion front. This move has allowed me to serve an more diverse constituency, which now includes the institutional consumer (ie., investment turned consumer banks, hedge funds, pensions, etc,) as well as the newbie individual investor who is just getting started - basically the two polar opposites of the investing spectrum. I am proud to announce major banks as paying clients, and brand new investors who take my book recommendations and opinions on true wealth and success to heart.

So, this is how I use my background and knowledge in new media, distributed computing, risk management, insurance, financial engineering, real estate, corporate valuation and financial analysis to pursue, analyze and capitalize on global macroeconomic opportunities. I have included a more in depth bio at the bottom of the page for those who really, really need to know more about me.

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