Saturday, 30 January 2010 13:20

Reggie Middleton vs Goldman Sachs, Round 2 Featured

Before I get started, I want all to realize that this is not Goldman bashing piece. I think it is a [relatively] well run company, but its PR machine appears to be from Kindergarten land, and the aura of invincibility that it enjoys(ed?) is highly undeserved, as a consequence its historical "aura-based" premium is absolutely unjustified. Case in point...

On December 8th of last year, I penned "Reggie Middleton vs Goldman Sachs, Round 1"wherein I challenged all to take a critical look at exactly how much money was lost by Goldman Sachs' clients. Well, here comes round 2, which is directed at Goldman (over)valuation.

Three months ago I explicitly warned my readers and subscribers about how outrageously priced Goldman Sachs was: Get Your Federally Insured Hedge Fund Here, Twice the Price Sale Going on Now! Monday, 19 October 2009.. Goldman was closed at $186.10 that day.

Although GS' had beaten street expectations (which everyone at should recognized as the game that it is), the company's share price has significantly run ahead off its fundamentals. Since December 2008, the company's tangible book value per share has increased by a modest 3.2% while its share price has increased by a whopping 92.1% with its Price-to-Tangible Book value per share ratio currently standing at 1.77x compared with 1.45x in 2Q09 and 0.45x in 4Q08.  Based on closing price as of October 18, 2009, GS' price-to-tangible book value per share is at 1.99x while average price-to-tangible book value per of its peers stood is 1.55x,implying a premium of 28% for the Goldman Sachs brand name. As I said, an expensive, federally insured, publicly traded hedge fund with a strong lobby arm and an even stronger brand management department.

Readers should take into consideration that this is the exact same argument that I posed a year and a half ago when I first shorted Goldman Sachs at $185! Where is it trading today? $186.43. This is after it had to be rescued by the government for fear of collapse!

Let's revisit history with an excerpt from Saturday, 05 July 2008, it's deja vu all over again...

I rode Goldman down to the $100 to $75 band, but it eventually bottomed somewhere around $50. Now it's right back where it started from, pre-bailout. Does it deserve to be there??? Inquiring minds want to know...

I consequently wrote "It appears as if the patina on Goldman's Stock is fading..." wherein I stated on the 15th of December (Goldman traded at $162.70):

"The amount of public resentment, potential for political backlash (yes, even Goldman can get stabbed in the back when a sacrificial lamb is needed), surfacing compensation issues (remember, on the Street, compensation is everything - there really is no company loyalty) and unwarranted premium added to this company's share price over the last few quarters appear to be culminating into another potential collapse in the company's share price. This is not investment advice, simply an anecdotal opinion.

I believe the Goldman premium will be reduced, along with its transient above market earnings potential/advantage (when the edge that it has is assimilated into the market). It probably cannot maintain its trading record for more than a few quarters (98% profitable days of trading out of a month is statistically impossible, but that is a story for another day), and its other value drivers still don' t look very promising. Last but not least, there is the matter of all of that trash still on the balance sheet. If the market's euphoric bear rally breaks, which it looks like it may (finally), then Goldman will break along with it. It has a long way to fall if it does."

Well, here we are on Jan 30th, 2010. Goldman's last closing price was $148.72, down 20% and primed to test their 52 week lows. Let's take a closer look at Goldman's last quarter then remind subscribers why they pay for my services. After all, just like in 2008, not one was talking about shorting the indestructible, government protected, almighty, infallible, uber-bailed out Goldman at their highs besides me (twice).

Reggie on Goldman's Q4 2009

My blog subscribers can download the full quarterly review and opinio here:  This reveiew has an updated valuation componet for Goldman, takng into consideration what we feel the stock is worth now, and also what could potentially happen if the market continues to slide further and signficantly. See

Non-subscribers (which, you all should be subscribers, but I'll forgive you for now), take note of this excerpt and screen shot from the subscription report.

With trading revenues dictating the overall profitability of investment banks like Goldman Sachs, important concerns are being raised about the business models of investment banks which are highly dependent on the trading income (highly volatile under current conditions) to sustain their profitability. Trading revenues (nearly 64% of the total net revenues in FY09) form a substantial portion of Goldman’s revenue stream and movements in this income stream determines the Company’s total revenues overall profitability. In 2009, trading revenues amount to nearly 63.9% of the total net revenues while the impact on earnings is magnified with the total trading revenues amounting to 145.6% of the total pre-tax income.

Comparing with the peers, the trading revenues accounts for highest percentage of total revenues in case of GS. The Company’s trading revenues are largely driven by the activity levels as well as spreads, both of which are market determined and decided by general macro-economic conditions. With nothing more uncertain than the macro-economic conditions and markets in US, this income stream is becoming increasingly volatile under the current circumstances. The future sustainability of this income is further dented by Obama’s recent policy announcements to curb proprietary trading (trading with no client related transaction involved and primarily done to earn profits by assuming greater trading risk). The administration is working out increased restriction on the risk-taking involved in earning prop trading revenues. The government is also planning to put restrictions on hedge funds and private equity transactions which will directly impact the revenues from Principal Investments of Goldman Sachs. Thus, apart from the risk of regulatory move that can seriously clamp down the trading revenues, the risk of deterioration in the general market condition, increase in volatility or a serious dislocation like the one witnessed in 2008 seriously undermine the future profitability of GS.

Click to enlarge full screen.

This multiple summary and graphs above also explains how Obama effectively cut the compensation GS, and to the lesser extent, othe banks employees. They are getting stock at the peak of a banking bubble - particularly after the most recent run up. I know I have heard pundits and analysts across the media saying that employees are getting discounted stock, but it is stock discounted off of a bubble at a time when banks are about to become worth a lot less - that is unless they find a way to do something else that is very productive contributory to growth (other than theirs) to replace extant yet dwindling revenue streams. Just take a look at the facts and figures above. They don't lie!

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 Professional2009-04-20 10:06:454.04 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!!!

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.

You know what most people don't realize is that it looks quite scary now as well.

If one were to strip out the revenues from prop trading, it would leave bards some balance sheet issue. Again, I query, should virtual hedge funds that pay out half of revenue as compensation trade at such high premiums to the rest of the market? I don't think so, and I have put my money behind the idea that the market will not think so in the near future either.


More of Reggie on Goldman Sachs

Free research and opinion

§ 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?

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Last modified on Saturday, 14 January 2023 12:12