Goldman Sachs is primed to lead the financial services sector
Few companies truly live up to their reputations. In 2007, as we launched our firm, Galliant Capital, we were introduced to a number of highly regarded investment banks. Based on our experience, only the Goldman Sachs Group ( NYSE: GS) met and even exceeded our expectations as it excelled in all areas, including prime brokerage, research and trade execution. The firm is best-of-breed in the financial services sector and we believe that its stock will continue to be a strong performer.
The company was founded in 1869 by Marcus Goldman and began as a small commercial paper dealer. Goldman was later joined by his son-inlaw, Samuel Sachs, and, soon after, the company changed its name to Goldman Sachs. It has since grown to become one of the largest financial services firms in the world. Throughout its history, Goldman has employed a significant number of high-ranking public officials, including former U.S. Treasury secretary Hank Paulson and current Bank of Canada governor Mark Carney.
Following the 2008 financial crisis and the bankruptcy of Lehman Brothers, Goldman converted from an investment bank into a bank holding company in order to gain access to capital from the U.S. Federal Reserve. As a result, the company was required to limit the amount of leverage used on its balance sheet. This provision helped reduce the company’s risk profile, especially during the severe economic recession.
Shortly thereafter, Goldman received an important vote of confidence from famed investor Warren Buffett. Buffett’s company, Berkshire Hathaway (NYSE: BRK.A/BRK.B), invested $5 billion in Goldman at a critical moment in time. By taking a stake in the company while many of its competitors were struggling to survive, Buffett helped bolster investment sentiment regarding Goldman’s long-term prospects.
Today, Goldman Sachs is once again a leading financial services institution. The firm generates revenue and income from four main divisions, including Investment Banking, Institutional Client Services, Investing and Lending, and Investment Manage- ment. Institutional Client Services accounted for 55 per cent of the company’s earnings in 2012 and is the company’s largest division.
Based on Friday’s closing price of $134.51, Goldman’s stock is trading at 52-week highs, but at a multiple of only 11 times 2013 earnings estimates. The company is anticipated to grow its earn- ings by 38 per cent annually over the next five years, while the industry is expected to grow by only 10 per cent. Goldman’s low valuation can be attributed in part to its Investing and Lending division, which includes the firm’s proprietary trading activities. This segment represented 25 per cent of the company’s earnings in 2012. While Goldman has a strong track record of generating trading profits, the market ascribes a lower valuation to these earnings as market participants believe they may be non-recurring in nature. However, since the firm continues to attract the best talent on Wall St. due to its high compensation and esteemed reputation, we believe that its trading profits should continue to flourish over the long term.
While its stock gained 40 per cent last year, Goldman also returned value to shareholders through share buybacks and dividends. The company’s strong balance sheet enabled it to repurchase more than five per cent of its shares outstanding during 2012 and the company has more than 34 million shares remaining in its current repurchase program, representing seven per cent of its $63 billion market value. Goldman also pays a $2 per share annual dividend to its shareholders.
Since the end of the recent economic crisis, financial stocks have handily outperformed the broader stock market. The Financial Select Sector SPDR ETF (NYSE: XLF), which represents a basket of financial stocks, has gained 190 per cent from its March 2009 lows, and in 2012 alone, it increased by 25 per cent.
Although we anticipate continued strength in the financial sector in 2013, we recognize that most financial stocks participated in the sector’s recovery over the last few years. We believe investors will benefit by concentrating now on only the highest-quality names in the sector, as we envision more of a stock picker’s environment going forward. With its leading market position, strong balance sheet and shareholder-friendly practices, Goldman Sachs is primed to lead the pack. Full disclosure: We own shares of Goldman Sachs, Berkshire Hathaway and the Financial Select Sector SPDR ETF in the Galliant portfolios.