Warren Buffett is finally cashing in on the upside to his famous 2008 rescue of the investment bank Goldman Sachs (GS) in which he bought $5 billion in preferred stock and negotiated a generous bonus in the form of stock warrants.
Those 5 year stock warrants have come due, and Buffett’s taking his stake in stock, not cash. If current prices stick until October, Buffett will score some 9 million shares from Goldman Sachs.
Goldman Sachs as an Investment
Today’s Goldman Sachs isn’t the same company it was in 2008, or in the 2000s at all. During the housing boom, Goldman, like many banks and investment banks, was rapidly leveraging up its balance sheet for such amazing, can’t-lose investments like mortgage backed securities among other exotic opportunities.
As we all learned, houses can go up in value, but they can also go down…quickly. So, too, can stock prices.
Since then, Goldman Sachs has made major changes in response to regulatory changes and its own outlook for its business model. The firm now operates with:
- Lower Leverage – The biggest change is to the company’s balance sheet. The leading pure-play in investment banking cut back on financial leverage, building up a capital base to a point where the firm has leverage of 13.5 times equity, compared to 27 times in 2007.
- Less Trading, More Deals – Proprietary trading is essentially gone under new Dodd-Frank legislation, but Goldman Sachs never really relied on prop desks to generate a substantial part of its income, anyway. Rather, Goldman Sachs generates most of its income from brokerage and institutional services, which made up 53% of total net revenue in 2012. This is a bit of a joke, of course, because its pretty difficult to distinguish between market-making and proprietary trading. What Goldman Sachs is up to today doesn’t seem to be attracting much attention from regulators, and the money is flowing!
- Growing Asset Management Divisions – Asset management fees are a boon for companies like Goldman Sachs, as they provide relatively consistent income with no risk to the firm’s capital. Asset management earnings are tied to the whims of the market, but Goldman Sachs is a strong, marketable name when it comes to raising new funds.
Valuing Goldman Sachs
Goldman Sach’s “safer” approach to its core business, with less leverage, is good for investors, especially when booms turn to bust. The company hasn’t sat entirely idle with ballooning cash balances, instead paying a $0.50 quarterly dividend while repurchasing shares to boost shareholder value.
The company cut shares outstanding from 514 million shares in 2009 to 469 million shares, acquiring its shares at a discount when opportunities emerged to purchase shares at less than book value. While the Fed approved of its repurchase and dividend plans, it did require Goldman to resubmit for stress test numbers later in the year. Given that the company trades at book value, future repurchases will be light. Its dividend plan isn’t especially taxing to the balance sheet, and should get easy approval.
Goldman’s no hard bargain, but it isn’t necessarily expensive, either. The company trades at a price equal to its book value, with return on equity coming in at just under 11%. Its diversified mix of businesses allow for upside in the current market. Low rates and higher stock market prices allow for more advisory and asset management revenues. It’s no surprise that Buffett doesn’t seem interested in a larger share of the company, given his preference for take-private deals as Berkshire Hathaway builds a cash balance.
At 10.3 times last year’s earnings and just over 9 times forward earnings projections, Goldman Sachs is a relatively cheap way to play the improvement in financials. A buyout boom, the re-emergence of spin-offs, and growing fee-earning assets under management give added upside potential.
All in all, Goldman Sachs is a safely-levered company that will provide safely-levered returns. Gone are the days of extreme returns on equity, but double-digit returns on equity should be here to stay. A prudent Goldman Sachs is a worthwhile stock to own, just don’t expect it to double overnight.
What are your thoughts on Goldman Sachs today? Are you a buyer or a seller?