Can You Believe There Are Still Analysts Arguing How Undervalued Goldman Sachs Is?
Those July 150 Puts Say Otherwise, Let's Take a Look
To begin with, Goldman Sachs produces more accounting revenue and accounting profits than its peers. This is because Goldman benefits from virtual monopoly pricing and advantages in several markets. Despite this advantage, when one factors in economic RISK and the cost of capital, Goldman doesn't fare nearly as well as the sell side makes it seem. Of course, the sell side rarely attempts to quantify risk, which is cool until reality rears its (sometimes ugly) head. Before we get to risk adjust returns, let's look at the simple accounting numbers and attempt to throw some logic on them...
Above, you see that GS has enjoyed a significant premium over its peers in terms of book valuation. This premium has actually increased over the past year. Let me be the one to remind you that no US company has every survived a criminal judgment, none. Arther Anderson was driven into bankruptcy from charges stemming from the Enron collapse, and that is despite the fact that the Supreme Court overturned the guilty verdict! Assuming, for the benefit of the doubt, GS can somehow set precedence, or more realistically, criminal charges are not filed, we still have to contend with:
- the SEC lawsuit
- the increased regulation, in particular the Volcker rule and derivatives oversight
- follow on litigation, which is virtually guaranteed, and virtually guaranteed to be extremely expensive, time consuming, and distracting from the core businesses.
- a general decline in business since we are coming off of a credit and risky asset boom and going into a sovereign debt crisis that will make FICC much less predictable (seeThe Next Step in the Bank Implosion Cycle??? for a more on how this could end with the Pan-European Sovereign Debt Crisis drama unfolding).
Taking all of this into consideration, you tell me... Does Goldman really deserve to be trading at such a premium considering the myriad risks it is currently exposed to PLUS the murky business and regulatory environment? They are also losing talent on the sales side, and at the MD level to boot. Today's market is starting to see things the Reggie Middleton way.
Now, let's factor in some more reality. No matter what your broker says about accounting earnings and revenues, they don't come free. They all have a cost of capital attached to them. Let's reference an excerpt from When the Patina Fades... The Rise and Fall of Goldman Sachs???
GS return on equity has declined substantially due to deleverage and is only marginally higher than its current cost of capital. With ROE down to c12% from c20% during pre-crisis levels, there is no way a stock with high beta as GS could justify adequate returns to cover the inherent risk. For GS to trade back at 200 it has to increase its leverage back to pre-crisis levels to assume ROE of 20%. And for that GS has to either increase its leverage back to 25x. With curbs on banks leverage this seems highly unlikely. Without any increase in leverage and ROE, the stock would only marginally cover returns to shareholders given that ROE is c12%. Even based on consensus estimates the stock should trade at about where it is trading right now, leaving no upside potential. Using BoomBustBlog estimates, the valuation drops considerably since we take into consideration a decrease in trading revenue or an increase in the cost of funding in combination with a limitation of leverage due to the impending global regulation coming down the pike.
Remember, practically everybody poo-poohed my research and opinion in 2008 when I said Goldman was drastically overvalued - Reggie Middleton on Risk, Reward and Reputations on the Street: the Goldman Sachs Forensic Analysis. Those 600% to 1000% gains on the put options proved otherwise. Speaking of which, those July 150 puts... Can you smell what the forensic analysis is cookin'???
For those who haven't read my review of Goldman's latest quarter performance, please do: A Realistic View of Goldman Sachs and Their Latest Quarterly Results
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Author: Reggie Middleton
Reggie
Middleton
Reggie Middleton, LLC
Perpetual Interests, LLCTM
http://boombustblog.com/
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.
Visit his blog Boom Bust Blog.
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