Stock of the week: Goldman Sachs (GS)

by Oct 23, 2020Market Reviews

Stock of the week: Goldman Sachs (GS)

The stocks of the week articles in the past usually discuss fascinating, high growth stocks.

If you think about buying a well-known ice cream shop for $100m, that makes $1m a year now but COULD make $100m in the future, would you? That’s quite expensive, no?

On the other side of the spectrum, we have your dry-cleaning business with chains all over the country, selling for $100 million, which makes $50 million now. Which out of the two businesses has more value?

As of late, we’ve been talking about companies that are similar to the ice cream shop – high growth, high price tag. This week the stock of the week, is equivalent to the dry-cleaning business – a value play.

Founded in 1869 by Marcus Goldman and Samuel Sachs, Goldman Sachs is an American Investment Bank and Financial Services firm. Their reach spans from managing the wealthiest individuals and institutions in world to consumer banking for you and me. However, the way they make their money has stayed the same for 150 years – Net interest Margin and Fees.

Alongside $5B in fines, Goldman executives agree to an unprecedented pay dock as punishment (Left: Lloyd Blankfein, Right: David Solomon)

Net Interest Margin
Look at what the bank is offering you for mortgage loans and look at what they pay you for keeping your money safe in their bank. The difference between the mortgage rate and what they pay you in interest is the net interest margin. This is how banks have been making money for centuries.

Fees and Asset Management
As banks modernized after Regan’s deregulation in the 1980s, securitization and share sales became more prevalent. With banks wedging themselves as the intermediary between investors and the market, they have promoted themselves as the bearer of information and that all transactions should be done through them. This has set them up to take fees for that information and have branched into asset management, which, of course, they take a fee from.

Goldman’s Catalyst:

We talked about buying high and selling low when the week’s stock was Tesla, where we stipulated that buying Tesla was buying at a high.

With Interest rates at an all-time low, many banks struggle to make revenues off the net interest margin, which is their bread in butter. Jerome Powell famously stated that “We are not thinking about raising rates” within the next five years. Therefore, we can deduce that the net interest margin will be relatively low in the next couple of quarters. However, once the Coronavirus is over, we should expect Jerome Powell to raise rates – therefore, we can also deduce that a majority of banks’ stock prices, including Goldman Sachs, are priced at a relative low.

Another catalyst is Goldman’s trading division, nearly doubling in the past year, with Equities and Fixed Income trading revenue coming in at around $7.1 Billion, the highest in 11 years, showing strong performance trying to make up for the lackluster net interest margin revenue.

Goldman’s Risks:

Amidst the Coronavirus, the Federal Reserve capped dividends and banned share buybacks as they believe that the Covid-19 crisis could trigger $700 Billion of loan losses, pushing banks to their capital minimums. Furthermore, the Fed has recently decided to extend the curbs until further notice, essentially disabling the profits’ distribution back to shareholders.

Another risk that they face is a reputational one. For the first time, a Goldman Sachs subsidiary was found guilty for their involvement in the 1MDB scandal. They have paid over $5 Billion in fines and admitted to paying $1.6 Billion in Bribes. Furthermore, in an unprecedented move, the US Justice Department decided to punish executives by docking their pay. This may prove detrimental to future institutional clients who may want to work with Goldman or any business that wants to IPO. Furthermore, litigation costs and fines have been hitting their EPS, missing expectations due to the penalties and litigation costs.

Goldman: Conclusion

Buy low, sell high. That’s the game. We know Goldman is at its low. The risk here is, when will it start reaching its high? If you’re looking for a long term buy, Goldman could be a good buy. However, this is most definitely a long term play with the stock trading at around a 17% discount from its all-time high.

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