Wednesday, 19 January 2011 09:30

Goldman Sachs Latest: Vindicates BoomBustBlog Research, Disappoints Sell Side Cheerleaders, Shows GS Is Just A Bank After All

Goldman Sachs posted a 53 percent decline in quarterly profit, due in large part to the reversion to mean of their outsized trading profits over the last several quarters - as duly warned in the BoomBustBlog research reports. As per CNBC:

Fourth-quarter net income after payment of preferred stock dividends totaled $2.23 billion, or $3.79 per share, compared with $4.79 billion, or $8.20, a year earlier. Net revenue fell 10 percent to $8.64 billion.

Analysts on average expected profit of $3.76 per share on revenue of $9 billion, according to Thomson Reuters I/B/E/S.

Net revenue dropped sharply, as we anticipated as well.

Net revenue in fixed income, currency and commodities slid 39 percent from the third quarter to $1.64 billion, reflecting what Goldman called "generally low client activity levels."

The Goldman, et. al. story is not over yet. There is still a material amount of legacy assets (losses) to be recognized at market value. The market is not returning to the point of inception of this stuff, and the true extent of the losses have yet to be taken. I have been uber bearish from this perspective, yet market prices appeared to disagree. The problem was simply a matter of gross, coordinated misrepresentation (a fancy way of saying "lying, on  a large scale - and with the cooperation of regulators"). I was absolutely correct, and now that the truth has come out, will there be any rule of law? Let's reminisce through referencing several posts from 2008 wherein I made clear that Goldman Sachs was much riskier than practically ANYBODY on the street and in the media recognized...

After all, it's not like they paid 10 points to Old Man Buffet for the hell of it. All of a sudden, sunlight started shining everywhere! Where did the sun rise from? Goldman's apparently captured friends in high places of regulation. Let's revisit the FASB tale: About the Politically Malleable FASB, Paid for Politicians, and Mark to Myth Accounting Rules. Remember, the change of these rules to the status of straight silliness what kicked off one of the greatest bear market rallies in the history of US publicly traded stocks. Now, nearly everything financial (as it relates to M2M) is overvalued.

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It looked as if I was wrong for some time, then the truth's ugly head started peaking out. See The Financial Times Vindicates BoomBustBlog’s Stance On Goldman Sachs – Once Again! Friday, January 14th, 2011.

Hmmmm! I walked through this in explicit detail in “When the Patina Fades… The Rise and Fall of Goldman Sachs??? and I did it without being privvy to Goldman’s financial innards. It was more or less common damn sense. Goldman and its employees do not walk on water, they do not shit gold, and they cannot perform miracles. If one takes an objective approach to their equity analysis, and simple plug the numbers into a spreadsheet (objectively) you would have come up with the exact same conclusions that I gave my subscribers all of these years. Let’s reminisce, shall we?

So, what is GS if you strip it of its government protected, name branded hedge fund status. Well, my subscribers already know. Let’ take a peak into one of their subscription documents (Goldman Sachs Stress Test<br /> 	Professional Goldman Sachs Stress Test Professional 2009-04-20 10:06:45 4.04 Mb – 131 pages). I believe many with short term memory actually forgot what got this bank into trouble in the first place, and exactly how it created the perception that it got out of trouble. The (Off) Balance Sheet!!!

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Contrary to popular belief, it does not appear that Goldman is a superior risk manager as compared to the rest of the Street. They may the same mistakes and had to accept the same bailouts. They are apparently well connected though, because they have one of the riskiest balance sheet compositions around yet managed to get themselves insured and protected by the FDIC like a real bank. This bank’s portfolio looked quite scary at the height of the bubble.

The perception of perfection, and the resultant overvaluation still persists, reference No One Can Say I Didn’t Warn Them About Goldman Sachs, Several Times… and the post that irked so many - 

 

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…

I bank mutliples

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 (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.

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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.

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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’???

gs July 159 puts on 4-30-10

More on Goldman Sachs

Premium subscription content and Goldman forensic analyis:

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Last modified on Thursday, 11 August 2011 04:26
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