Should I Buy Goldman Sachs? 3 Pros, 3 Cons

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Goldman Sachs (NYSE:GS), Wall Street’s most powerful investment bank, absolutely clobbered analysts earnings forecast when it released second-quarter results Tuesday morning. And that was even after the Street had slashed estimates like mad over the past few weeks. The Great Vampire Squid looks to be back to its winning ways, at least when it comes to delivering healthy upside surprises.

Indeed, Goldman’s earnings beat the Street by a shocking 68 cents a share. The bank has now eclipsed the analysts’ average bottom-line estimate for three consecutive quarters after missing for two periods in a row. The firm has also topped the Street’s top-line forecast for two straight quarters, following a string of three straight misses.

But that doesn’t mean it’s business as usual for investment bank. Goldman is beating some very low expectations, after all, and profit and revenue are in decline. For the most recent quarter, income fell 11% on a 9% slide in net revenue.

Blame the usual suspects. A dearth of deal activity meant Goldman garnered less business from advising on mergers and acquisitions. Again. The same goes for the precipitous drop in initial public offerings.

And it’s tougher to make money trading your own book, especially given the brave if boring new world of impending financial regulations like Dodd-Frank and the bigger capital cushions required by Basel III.

So, are the days of Goldman’s gunslinging ways over? Or is the bank a buy as it adjusts to a more prosaic future of less stellar results? Let’s take a look at the pros and cons:

Pros

Valuation. Goldman’s stock has taken a beating over the past couple of months — not to mention the last year. It’s off about 24% over the trailing 52 weeks, lagging the broader market by a painful 28 percentage points. And after climbing as high as $128 by late March, shares are now stuck in the mid-$90s.

That pummeling has made the stock look reasonably attractive on a relative valuation basis. Goldman’s forward price-to-earnings ratio (P/E) of 9.7 offers an 18% discount to its own five-year average, according to Thomson Reuters Stock Reports. It trades at an even deeper discount to the S&P 500, despite having greater earnings growth potential.

Boring is beautiful. Goldman is slashing costs and embracing new revenue streams in anticipation of having to take less risk. The firm is establishing a private bank for wealthy individuals and corporations, according to The Wall Street Journal. True, that’s a relatively boring, low-margin business, but it gives Goldman another source of capital and the opportunity to cross-sell financial products.

Goldman also sold off its hedge fund administration business, which was involved in back-office functions like accounting and tax reporting. Both strategic moves make sense in world where swing-for-the-fences, proprietary risk-taking will be more constrained.

Rebound. The sluggish M&A, IPO and capital markets won’t persist forever. It may take a while — a good long while — but when the global economy and markets stabilize enough to create corporate confidence, Goldman will be there to capitalize. Yes, the bank’s image has been bruised, but when companies need to tap the bond and equity markets, Goldman is still the marquee name. The same goes for advising on deals.

The investment banking business might be slow for now, but it’s hardly down for the count.

Cons

Known risks. Regulatory risk looks to have been sufficiently discounted in Goldman’s stock, but global credit risk sure hasn’t. It can’t be — and that’s a reason why shares have been hammered since spring. If the European debt crisis blows up into a full-blown meltdown — another Lehmann event — Goldman, like all financial stocks, will get creamed.

The current environment of extreme economic and financial uncertainty isn’t doing the stock any good, and it’s hard to see the picture improving materially soon.

Market volatility. Uncertainty is also wreaking havoc on the markets, which isn’t doing Goldman’s business in underwriting stock and bond offerings any good. IPOs have all but dried up, and blockbuster M&A deals have gone to ground.

The lack of juicy deal fees is hurting the top and bottom lines, and there’s no telling when the trend will reverse.

Black Swans. Regulatory risk? Check. European contagion? Check. Recession? Check. There’s no shortage of very worrisome risks that need to be baked into Goldman’s share price, but the worst ones are the unknowable ones. Ever since the financial system seized up four years ago, the fear of being blindsided  has tamped down financial stocks.

And well it should. After all, the only thing that saved Goldman from becoming Wall Street’s biggest punching bag lately was JPMorgan Chase’s () $5.8 billion-and-counting trading loss. That the best risk-managers on the Street could blow themselves up with bad derivatives bets is a bracing reminder that hubris can undo any bank at any time.

Verdict

Goldman looks like a decent bargain bet for long-term value investors capable of sticking it out through bouts of extreme volatility. The market has shown it’s willing to pay close to $130 a share when the outlook is more sanguine.

But tactical investors should probably sit this one out. A sluggish U.S. economy and looming presidential election make defensive plays and dividends a better idea over the next few months — not risky financials like Goldman.

As of this writing, Dan Burrows did not hold any of the securities mentioned here.


Article printed from InvestorPlace Media, https://investorplace.com/2012/07/should-i-buy-goldman-sachs-3-pros-3-cons/.

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