Since 2007, Goldman Sachs Group, Inc. (NYSE:GS) has struggled to return to an acceptable ROE figure. The days of 30+% ROEs are quite likely gone due to significantly reduced leverage, but Goldman is also operating in a poor economic environment. Operating income now stands at only 14%, far below historical levels in the low 20s.
It’s not all bad though, in 2008, when Goldman changed into a bank holding company, it gained a valuable source of liquidity in the Fed discount window. Also, with Goldman passing the stress test, the threat of a government mandated capital raise has decreased. In fact, Goldman was actually allowed to buyback more shares and increase the dividend.
Will Goldman return to an appropriate level of profitability in the long run? I think so, when you try and regulate a market you usually have unintended consequences (higher spreads and pricing). “If the diner can’t charge for ketchup they might just charge more for the hamburger.”
That being said, if the current form of the Volker rule, which includes “key exemptions to allow banks to hedge risk and make markets for customers seeking to trade securities” was to change (as a reaction to JP Morgan’s recent screw up) it would hit Goldman’s future profitability far harder than their competitors.
Also, if we enter a period of prolonged economic contraction this investment will hardly be a winner.
At 76% of tangible book (70% of stated) I feel the risk is priced in. But investors must realize that with any highly leveraged institution the possibility of losing your entire investment is very possible.
| Goldman Sachs |
Risks:
Prolonged economic contraction
Government regulation (Volker rule, Dodd Frank)
Inability to earn an appropriate return due to new capital requirements and reduced leverage
Opaque balance sheet
Nick Leeson loss (system failure)
Further debt downgrades & capital raises
| Goldman Sachs P/B |
Disclosure: Long GS
By Hardcore Value
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