Financial, Real Estate, Stock Markets Trends and Current Affairs

thumb_image001_copyLearning to fly with tentacles instead of wings may prove difficult for the Squid!

Note: Subscribers can download the GS 3rd quarter review with the updated valuation opinion here Goldman Sachs Q3 update Final (482.35 kB 2011-11-03 03:03:51)

In our Goldman Sachs update note, “Show me how to trade” (August 2011), we challenged Goldman Sachs’ ability to create alpha. Besides Goldman’s apparent lack of skill in generating returns in downward markets, we also presented an analysis on how its share price is driven by momentum (equity markets) instead of the commonly accepted metric of book value. Those who would have followed the traditional school of thought (sell side) by bidding the price up instead of down would have seen their capital erode by 9%; the stock is down 9% since our most recent publication. Below are some of the extracts from our previous note alongside updated charts including Q3 results to peruse before we delve further into the quarterly results the BoomBustBlog way.

“Unfortunately, despite the entire start syndrome attached to Goldman Sachs, its prop desk is yet to exhibit the ability to create alpha, let alone match the returns of boombustblog.com. The table in the exhibit shows Goldman Sachs’ trading (under) performance vis-à-vis S&P”

“Given the high correlation of Goldman’s prop trading desk to equity markets and taking into consideration the state of equity markets in Q2-Q3, it would be interesting to see how Goldman Sachs share perform in the coming quarter”

‘Goldman Sachs’ share price is driven less by book value per share and is driven more by momentum (multiple)”

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With Goldman Sachs return on equity (ROE) already under considerable pressure to meet even its cost of capital, additional strains on capital could put further pressure on its profitability. In Q3 ROE declined to a negative 2.6% from 6.1% in Q2 and 10.4% in Q3 2010, Goldman Sachs return on equity has declined substantially due to de-leveraging in an adverse market (the absolute wrong time to deleverage, yet the time when most banks seek to do it) and is below its current cost of capital. With ROE down to sub10% from c40% during pre-crisis levels, there is no way a stock with high beta as Goldman Sachs could justify adequate returns to cover the inherent risk. For Goldman Sachs to trade back at 200 it has to resume its ROE of 20% which means it has to increase its leverage back to pre-crisis levels of c25x. With curbs on banks leverage and de-risking this seems highly unlikely. image006_copy

Two months or so ago (Monday, 22 August 2011), I penned the public blog post that also relased my most recent research on Goldman Sachs - The Squid Is A Federally (Tax Payer) Insured Hedge Fund Paying Fat Bonuses That Can't Trade In Volatile Markets? Who's Gonna Tell The Shareholders and Tax Payer??? -  as excerpted:

The chart below demonstrates how the volatility of the revenues from the trading and principal investments trickles down into volatility of the total revenues and profits of Goldman Sachs. I don’t call Goldman the world’s most expensive federally insured hedge fund for nothing!

And for those who haven't been following my Squid Hunting series, there's a lot more to come from those boys at 200 West Street. If you want to know what will happen next, just look at the first few pages of the lastest Goldman subscription docs (click here to subscribe):

• Goldman Sachs Q3 Forensic Review - Retail
• Goldman Sachs Q3 Forensic Review - Professional

After all, eventually someone must query, So, When Does 3+5=4? When You Aggregate A Bunch Of Risky Banks & Then Pretend That You Didn't?