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A Realistic View of Goldman Sachs and Thier Lastest Quarterly Results
I’m about to go over Goldman Sach’s 1st quarter 2010 results, but
before I do, let’s recap the last quarter’s price movement and the
consequences of believing in infalliable name brands. This is basically a
continuation of the rant - So,
How Many Banks and Analysts Were Bearish On Goldman Before Today?
and Is
the Threat to the Banks Over? Implied Volatility Says So. Some may
ask why I’m being so generous in regards to the extent of this quarter’s
earning review. Well… A European institutional subscriber recently
stated he was able to get the same content found in my offerings from
his investment bank research. Whaaatt!!! I told him that he probably
wasn’t reading the subscriber content. He wrote back stating that that
wasn’t the case. He also said that he doesn’t see any fundamental
analysis in the work. I nearly fell out of my chair. Hmmmm. Well, on
the day that Goldman executives are due to testify before the Senate,
let’s review the opinions of the ONLY entity that I know of that had a
bearish perspective (rightfully and profitably so – twice and counting)
on Goldman Sachs. If I am not mistaken, nearly every bank and analyst
(save Meredith Whitney, you know I love you 
) had a strong buy or hold on this
company both back in 2008 and last month. So much for relying on that
name brand investment bank research. For any others who may hold the
sell side propaganda machine in such high regard (or is it me in such
low regard), might I recommend the following two posts before we move
on: For
Those Who Chose Not To Heed My Warning About Buying Products From Name
Brand Wall Street Banks, and “Blog
vs. Broker, whom do you trust!”.
Map
those base Jumping, spilunking, sky diving drops in Goldman's share
price with the research linked below. This company is very, very risky
and the risks are there for all to see. All you have to do is look for
them!!!
To recap:
GS return on equity has declined substantially due
to deleveraging 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. Using your method,
our valuation would drop from where it is to an even lower point.
Second, it still has a bunch of trash on its balance sheet, see
Reggie
Middleton vs Goldman Sachs, Round 2. If you look at the period of
the most recent credit bubble, Goldman did everything that the other
failed and bailed out banks did: leveraged up on trash assets, invested
in and sold the worthless junk, and ran to the government for aid and
bailouts:
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 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!!!
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.
Now, on to the latest GS results:
1Q10 Results review
In 1Q10, GS reported 33% (q-o-q) and 36% (y-o-y) improvement in net
revenues to 12.8 billion from $9.6 billion in 4Q09 and $9.4 billion in
1Q09, largely driven by trading revenues which jumped 82% (q-o-q) and
61% (y-o- y) to $9.2 billion on the back to increased client activity
while bid-ask spreads tightened to some extent. Contribution of trading
revenues has been inching up with trading revenues accounting for 72% of
the total net revenues in 1Q10 against 52.5% in 4Q09 and 60.5% in 1Q09.
Revenues from investment banking were up 44% (y-o-y) but down 28%
(q-o-q) at $1.18 billion and revenues from asset management and
securities services were down 1% (y-o-y) and 16% (q-o-q) at $0.9
billion. Comp ratio was down to 43% from 50%, last year and the
compensation expense stood at $5.4 billion. Non compensation expense was
2% higher as compared to 1Q09 largely owing to higher levels of
business activity, charitable contribution of $40 million and net
provisions for regulatory proceedings of $21 million.
The surge in trading revenues trickled down to the bottom line and
the net earnings grew nearly 91% (y-o-y) to $ 3.5 billion from $1.8
billion in 1Q09.
The BoomBustBlog view
For those who have forgotten the implications of the highly leveraged
and opaque financial holdings (the true value of which rests at
the mercy of market sentiment) and can turn blind eye to the highly
volatile nature of the trading revenues combined with a literal tsunami
of regulatory pressure and potential litigious onslaught (all issues
which we have repetitively brought up in the past as what
appears to be the sole voice of contrarian reason), Goldman Sachs
holds a strong investment proposition. However, if fundamental
considerations such as the company’s solvency, true economic profit
(not the accounting earnings you hear preached from your brokerage’s sell side marketing
propaganda research reports) and the sustainability of
income are to be considered, GS should NOT appear among the preferred
lot.
GS swims and sinks with the financial markets and the performance at
the trading desks determines not only the profitability, but the
survival of the Company. The market’s unfounded exuberance (largely
driven by liquidity rather than fundamentals), combined with the
collapse or near collapse of 3 of its 4 largest competitors is enabling
GS to generate extraordinarily strong trading results. Trading revenues
which account for more than 60% of the revenues not only dictate GS’s
profitability but also serves as a cushion to absorb the write-downs on
the investments. Thus, Goldman Sachs is amongst the most vulnerable to a
major market disruption which can severely dent its earnings stream and
expose it substantial equity erosion from investment write-downs. Apart
from that, the recent fraud charges filed against GS not only adds to
the risk of incurring huge litigation costs but also add to the risk of
tighter regulation and oversight of the sector which can hinder the
business activity in the coming years.
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…
As of December, 2009, the GS’s investments portfolio amounted to $342
billion (nearly 580% of the tangible equity) out of which cash
instruments amount to nearly $267 billion (nearly 450% of the tangible
equity) while the rest was the fair value of the derivatives
instruments. Composition of cash instruments has changed substantially
over the last year with a substantial proportion moved from mortgage backed
securities and bank loans to foreign government securities.
However, given the heightened sovereign risk environment, the money
parked in government (US or foreign) securities is no longer safe from
serious write-downs. From the frying pan and into the fire??? See LTTP
(Late to the Party), Euro Style: Goldman Recommends Betting On
Contagion Risk In Portuguese, Spanish And Italian Banks 3 Months After
BoomBustBlog for what we see coming down the pike. Subscribers,
peruse the Global Macro and Commercial Banking sections of the downloads
for relevant subscription material.
While little disclosures are made about the write-downs on the total
portfolio, information about realized and unrealized losses on level 3
assets (highly illiquid) gives some idea about the amount of write-downs
being recorded on various types of investment securities. Although
level 3 assets amount to just 13% of the total cash instruments, the
realized and unrealized losses have been significantly influencing the
total revenues from trading and principal investments.
Level 3 cash instruments came down nearly 30% to $34.9 billion
(59.3% of tangible equity) as of December, 2009 from $49.6 billion as of
November, 2008 largely owing to sale of nearly $8.6 billion and
write-downs (realized and unrealized losses) of nearly $3.0 billion.
Write-downs on level 3 assets have declined sharply with the total
investment losses (realized and unrealized) coming down sharply. GS
recorded a gain of nearly 1.2% in 4Q09 against a peak loss rate of
nearly 16.8% in 4Q08.
Level 3 cash instruments portfolio largely consist of equities
and convertible debentures, mortgage backed securities, bank loans,
corporate debt securities etc. Break-up of the realized/unrealized gains
or losses for various types of securities in the level 3 portfolio was
not available prior to 1Q09. However, looking at the trend over the last
four quarters, largest improvement is seen in the corporate debt
securities followed by CMBS and equities and convertible debentures.
Based on the following table, it is observed that while situation is yet
to stabilize in markets like commercial real estate, GS has “imagined modeled”
quite optimistic assumptions when valuing the related securities.
Subscribers can find our most recent valuation
estimates of Goldman Sachs here - GS
4Q09 Final Review and Updated Valuation, current as of January
2010, the month I started reiterating my warnings about this company’s
drastic overvaluation.
More of Reggie on Goldman Sachs
Reggie
Middleton vs Goldman Sachs, Round 2
Reggie
Middleton Personally Congratulates Goldman, but Questions How Much
More Can Be Pulled Off
Get Your Federally Insured Hedge
Fund Here, Twice the Price Sale Going on Now!
Middleton on Goldman Sachs’ fourth quarter, 2008 results
and Morgan losses in the news, about 11 months late
vs. Broker, whom do you trust!
business on Goldman Superheroes
Middleton asks, “Do you guys know who you’re messin’ with?”
Middleton on Risk, Reward and Reputations on the Street: the Goldman
Sachs Forensic Analysis
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?
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premium Stuff!
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The best trading strategy the is, is that you have to look to the name of the company. For Goldman Sachs for example, it says "GOLD MAN!" and as gold is rising, Goldman does to.
NOW ANYBODY TRY TO MESS WITH THIS ANALISYS, I'LL KICK HIS ASS!!
Maybe you should edit your post so it makes sense before you start kicking ass.
If he adds a few blowhard comments like "I told you all the market was going down" and "I told you all the market was going to go up"(absent of hard dates of course), in conjunction with hundreds of links to his pay site then he would sound just like Reggie. No?
GS can't run, can't hide.
awesome stuff.
reggie is the best! i love his work!