6.9 C
New York
Friday, March 29, 2024

Can You Believe There Are Still Analysts Arguing How Undervalued Goldman Sachs Is? Those July 150 Puts Say Otherwise, Let’s Take a Look

Courtesy of Reggie Middleton

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:

  1. the SEC lawsuit
  2. the increased regulation, in particular the Volcker rule and derivatives oversight
  3. follow on litigation, which is virtually guaranteed, and virtually guaranteed to be extremely expensive, time consuming, and distracting from the core businesses.
  4. 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 (see#3366ff;”>The 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

More of Reggie on Goldman Sachs

Reggie Middleton vs Goldman Sachs, Round 2

Reggie Middleton Personally Contragulates Goldman, but Questions How Much More Can Be Pulled Off

Get Your Federally Insured Hedge Fund Here, Twice the Price Sale Going on Now!

  • Reggie Middleton on Goldman Sachs’ fourth quarter, 2008 results
  • Goldman and Morgan losses in the news, about 11 months late
  • Blog vs. Broker, whom do you trust!
  • Monkey business on Goldman Superheroes
  • Reggie Middleton asks, “Do you guys know who you’re messin’ with?”
  • Reggie Middleton on Risk, Reward and Reputations on the Street: the Goldman Sachs Forensic Analysis
  • Reggie Middleton on Goldman Sachs Q3 2008
  • §  As Reality hits, the Masters of the Universe are starting to look like regular bank employees

    Reggie Middleton’s Goldman Sach’s Stress Test: Breaking Ranks with the Crowd Once Again!

    Who is the Newest Riskiest Bank on the Street?

    More premium Stuff!

    Goldman Sachs Report June 21, 2008 2008-10-20 16:48:01 361.18 Kb

    Reggie Middleton on Goldman Sachs’ fourth quarter, 2008 results

    Goldman Sachs – Buffet’s strategic investment and public offering 2008-09-26 02:29:15 895.36 Kb

    Goldman Sachs’ Bank Holding Company Fundamental Valuation and Forensic Analysis – Professional 2008-12-18 10:12:37 267.49 Kb

    Goldman Sachs’ Bank Holding Company Fundamental Valuation and Forensic Analysis – Retail 2008-10-20 15:45:05 348.99 Kb

    GS ABS Inventory 2008-02-25 06:48:56 1.22 Mb

    Goldman Sachs Valuation Model updated for PPIP – Retail 2009-04-04 19:50:51 388.04 Kb

    Goldman Sachs’ Bank Holding Company Fundamental Valuation and Forensic Analysis – Professional 2008-12-18 10:12:37 267.49 Kb

    Subscribe

    Goldman Sachs Stress Test Retail2009-04-20 10:08:06 720.25 Kb – 17 pages

    Goldman Sachs Stress Test Professional 2009-04-20 10:06:45 4.04 Mb – 131 pages

    Subscribe
    Notify of
    0 Comments
    Inline Feedbacks
    View all comments

    Stay Connected

    157,450FansLike
    396,312FollowersFollow
    2,280SubscribersSubscribe

    Latest Articles

    0
    Would love your thoughts, please comment.x
    ()
    x