Goldman Sachs Group Inc (GS)

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Buy Goldman Sachs Stock Because Wall Street Is Recovering Faster Than Main Street
By: Barron's | June 14, 2020

Investors looking at Goldman Sachs Group have tended in recent years to focus on what’s missing.

It doesn’t have a big consumer business. It is not a major commercial lender. Its first-ever investor day in January generated limited excitement. Because of what investors have found lacking, shares of Goldman (ticker: GS) have languished at a low valuation compared with its banking peers, based on earnings and book value.

Overlooked has been Goldman’s strengths: strong risk management, a powerhouse investment bank, and a CEO, David Solomon, who is pushing to build an online banking franchise, broaden relationships with corporate clients, and expand a lucrative alternative-asset-management business, which includes private equity.

Goldman may never become a leading bank on Main Street. But given the uncertainty over a Main Street economy still struggling with the effects of the Covid-19 pandemic, the bank that is emblematic of Wall Street looks like a good bet for investors.

The firm is well positioned for the current environment, with a corporate and institutional focus and little exposure to consumer and small-business lending. And Goldman stands to gain from ultralow interest rates, unlike rivals whose margins are under pressure.

Its huge trading business had a blockbuster first quarter and could be on pace for a lucrative second quarter, capitalizing on market volatility and elevated volume.

“Goldman has less exposure to credit and interest-rate risk relative to the average bank,” says Mike Mayo, the banking analyst at Wells Fargo. “It has three times more capital per dollar of loans than the average big bank. It’s one of the best risk managers in financial services, and its bread-and-butter investment-banking business is still best-in-class.”

Investors are starting to take notice. Goldman shares have outperformed those of rivals, falling 12% so far this year against an average drop of roughly 35% for JPMorgan Chase (JPM), Bank of America (BAC), Citigroup (C), and Wells Fargo (WFC). The Dow Jones Industrial Average has fallen 10% in 2020.

Goldman’s stock, now around $200, looks appealing, trading below its tangible book value of $215 a share and at a discount to most of its peers. The stock is no higher than where it traded in 2007. And the firm has a market value of about $70 billion, making it one of the smallest of the six largest U.S. banks. It’s less than half the size of online-payments leader PayPal Holdings (PYPL)

Mayo has an Overweight rating on Goldman and recently lifted his price target on the stock to $255 from $230.

“Goldman’s clout with governments, corporations, and investors around the world is as strong as ever, even while its relative market value has shrunk,” Mayo says. “Its market cap to clout ratio has never been lower.”

A key event to watch for Goldman will be the results of the annual stress tests of the top U.S. banks by the Federal Reserve on June 25. RBC analysts wrote this past week that Goldman may get the green light from the Fed to increase its dividend.

“For Morgan Stanley and Goldman Sachs, with big trading books and modest loan books, trading losses are the governing factor,” notes Eric Hagemann, a senior research analyst at Pzena Investment Management, which has held the stock for several years. “There was a severely adverse market environment in the first quarter, and there weren’t material trading losses. Can the Fed credibly model enormous trading losses in the stress test, given the experience in the first quarter?”

“That could be favorable for the capital requirements of Goldman and Morgan Stanley,” he says.

Goldman’s dividend yield is 2.6%. It has one of the lowest—and safest—dividend payout ratios among its peers based on projected 2020 earnings.

Stock buybacks, which Goldman and other large banks collectively suspended in March, are still unlikely in the coming year, however, amid a weak economy and depressed earnings for the industry.

Much has changed since the 151-year-old firm—public since 1999—stood astride Wall Street like a colossus. Regulations and capital requirements imposed after the 2008-09 financial crisis have crimped trading margins for banks. Technology has become increasingly important in finance. And the locus of power has arguably shifted to an asset manager, BlackRock (BLK).

The flat-lining of Goldman’s stock in recent years is a reflection of how the firm has wrestled with these changes.

“I would say that the strategy under the prior management was to not change who they were and wait for a better environment that would be more conducive to their traditional areas of strength,” Hagemann says.

Since Solomon took the reins of Goldman in October 2018 from longtime CEO Lloyd Blankfein, the bank has begun to pivot.

“Under Solomon, the view has been that if we’re going to be regulated like a bank, we might as well enjoy the benefits of a deposit franchise and a diversified set of revenue streams.”

Goldman didn’t make Solomon or its top executives available to speak to Barron’s.

There is periodic speculation that Goldman Sachs will merge with a large bank—recent talk involved Wells Fargo. That’s probably a long shot.

At a Bernstein presentation in May, Goldman President John Waldron played down the prospects of a “transformational” deal. “The bar goes up exponentially when we think about something that’s much larger or much more impactful to the whole of the firm,” he said, citing financial, cultural, integration, and execution issues.

Rather than merge with a bank, Goldman is creating one internally. It views itself as a Netflix-like disrupter in consumer banking because it lacks the high-cost network of branches that its larger competitors possess...

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