...and Going with Goldman
06/24/2005 12:00 am EST
"A rebounding equity market, smart risks, and growing businesses bode well for Goldman Sachs, the banking titan; that's why it has S&P's highest rating," says Stephen Biggar regarding the latest "Stock of the Week" in Standard & Poor's The Outlook. Here's his review.
"We think the Goldman Sachs Group (GS NYSE), one of the world's leading investment-banking and securities companies, is benefiting from improving global equity markets, a pickup in mergers and acquisitions (M&A) activity, and gains in merchant banking. Trading and principal investments accounted for 65% of net revenues in fiscal 2004. Results at its trading operations have been volatile on a quarterly basis, but we note that the segment has demonstrated strong results over the past decade. Although it has the highest value-at-risk (a measure of market risk in trading positions) among its major competitors, we view its willingness to take significant trading risk for appropriate reward as a competitive advantage.
"In its principal investments business, Goldman invests in private-equity deals as well as real estate. At the end of fiscal 2004, principal investments consisted of $820 million in real estate and $3.83 billion in corporate investments. We view its significant market position in prime brokerage as a competitive advantage. The asset-management and securities services business accounted for 19% of net revenues in fiscal 2004, with assets under management at $452 billion at the end of fiscal 2004. Goldman experienced net client inflows of $52 billion in fiscal 2004, across all asset classes. That's up significantly from $15 billion in the previous year.
"Concerns over hedge-fund profitability have recently weighed on Goldman's valuation. However, over the long term, hedge-fund assets will grow, in our view. And we see Goldman as primarily an intermediary, committing its capital, leveraging its market information, and managing risks in order to facilitate customer-driven activity. Despite quarterly volatility, we view Goldman's various segments as growth businesses over the long term, worthy of a higher multiple. The firm's stock-buyback program and consistent returns on tangible equity above its 20% target should also help support its valuation, we believe.
"We forecast earnings per share of $9.70 in fiscal 2005, up from $8.92 in fiscal 2004, aided by prudent expense growth and merchant-banking gains. Goldman has had increased earnings consistency, in part, due to its businesses being diversified. Its profit picture in fiscal 2005 will be aided by continued prudent expense management, we believe. We expect Goldman to use its strong free cash flow to pay dividends and repurchase common shares in fiscal 2005. The shares recently traded at a price-earnings ratio of about ten times our fiscal 2005 EPS estimate, a significant discount to both Goldman's peers and the shares' historical average p-e multiple of about 17 times. Goldman has traded at an average p/e of over 15 times since its IPO in 1999.
"We think its multiple can recapture its premium as the company demonstrates consistency of earnings and potential for increased M&A activity. Add this to its competitive advantage due to its willingness to make large proprietary investments and its cautious risk-management approach. We'd note that we also think Goldman could win additional business, given clients' potential concerns about management-control issues, reduced employee morale, shareholder dissent, and media attention at Morgan Stanley, especially after news of the planned departure of that firm's embattled CEO. The stock has our highest 5-star buy rating."