I have warned my readers about following myths and legends versus reality and facts several times in the past, particularly as it applies to Goldman Sachs and what I have coined "Name Brand Investing". Very recent developments from Senator Kaufman of Delaware will be putting the spit-shined patina of Wall Street's most powerful bank to the test. Here is a link to the speech that the esteemed Senator from Delaware (yes, the most corporate friendly state in this country). A few excerpts to liven up your morning...

Mr. President, last Thursday, the bankruptcy examiner for Lehman Brothers Holdings Inc. released a 2,200 page report about the demise of the firm which included riveting detail on the firm’s accounting practices.  That report has put in sharp relief what many of us have expected all along:  that fraud and potential criminal conduct were at the heart of the financial crisis.

...  Only further investigation will determine whether the individuals involved can be indicted and convicted of criminal wrongdoing.

I have warned my readers about following myths and legends versus reality and facts several times in the past, particularly as it applies to Goldman Sachs and what I have coined "Name Brand Investing". Very recent developments from Senator Kaufman of Delaware will be putting the spit-shined patina of Wall Street's most powerful bank to the test. Here is a link to the speech that the esteemed Senator from Delaware (yes, the most corporate friendly state in this country). A few excerpts to liven up your morning...

Mr. President, last Thursday, the bankruptcy examiner for Lehman Brothers Holdings Inc. released a 2,200 page report about the demise of the firm which included riveting detail on the firm’s accounting practices.  That report has put in sharp relief what many of us have expected all along:  that fraud and potential criminal conduct were at the heart of the financial crisis.

...  Only further investigation will determine whether the individuals involved can be indicted and convicted of criminal wrongdoing.

Tuesday, 02 February 2010 18:00

Continuing the Goldman Sachs Valuation Debate

As mentioned in my previous posts, I have been engaged in a discussion of the valuation of Goldman Sachs and investment banks in general. For the background behind this discussion, reference "Reggie Middleton vs Goldman Sachs, Round 2" and "Readers Comments on Goldman's Valuation".

Here is how it has played out.

ANALYST: Do you think GS or any other bank that is seen as a going concern should be valued at PB anymore, particularly now that the recession is over. I don't think markets are valuing banks seen as going concern on P/B (particularly xx/subs content used for GS).

Let's say it this way. I know the merits of PB but shouldn't it be used to value banks during recessions. Post recession, historically as well, analysts and markets switched to alternative valuation method for banks since PB would give us a base value during recession, and is good proxy during liquidation process that would determine shareholders' value in case bank has to wind up

Assuming GS has ROE of 15%. What about future cash generation now that we have revenue visibility? Or probably you don't expect GS to survive for next 5 yrs. Ok let's say this way, If you value GS with PB of xx with ROE of 15% two years down the line you would expect the book value to increase by 32% (assuming 0% payout ratio) and in five years more than double. Given that I-banks have high ROE this would be conformist, and not "realistic" as some argue, to value an I-bank.

Ideally banks (both commercial and investment banks) should be valued on discounted cash flow methodology taking into consideration cost of equity and future cash flows. But since banks have highly liquid balance sheet, traditional DCF used for industrials might ignore the merit in current balance sheet strength. So there is a need to maintain a trade-off that considers both the virtues - balance sheet strength and future accretion.

Tuesday, 02 February 2010 18:00

Continuing the Goldman Sachs Valuation Debate

As mentioned in my previous posts, I have been engaged in a discussion of the valuation of Goldman Sachs and investment banks in general. For the background behind this discussion, reference "Reggie Middleton vs Goldman Sachs, Round 2" and "Readers Comments on Goldman's Valuation".

Here is how it has played out.

ANALYST: Do you think GS or any other bank that is seen as a going concern should be valued at PB anymore, particularly now that the recession is over. I don't think markets are valuing banks seen as going concern on P/B (particularly xx/subs content used for GS).

Let's say it this way. I know the merits of PB but shouldn't it be used to value banks during recessions. Post recession, historically as well, analysts and markets switched to alternative valuation method for banks since PB would give us a base value during recession, and is good proxy during liquidation process that would determine shareholders' value in case bank has to wind up

Assuming GS has ROE of 15%. What about future cash generation now that we have revenue visibility? Or probably you don't expect GS to survive for next 5 yrs. Ok let's say this way, If you value GS with PB of xx with ROE of 15% two years down the line you would expect the book value to increase by 32% (assuming 0% payout ratio) and in five years more than double. Given that I-banks have high ROE this would be conformist, and not "realistic" as some argue, to value an I-bank.

Ideally banks (both commercial and investment banks) should be valued on discounted cash flow methodology taking into consideration cost of equity and future cash flows. But since banks have highly liquid balance sheet, traditional DCF used for industrials might ignore the merit in current balance sheet strength. So there is a need to maintain a trade-off that considers both the virtues - balance sheet strength and future accretion.

Saturday, 30 January 2010 18:00

Reggie Middleton vs Goldman Sachs, Round 2

Before I get started, I want all to realize that this is not Goldman bashing piece. I think it is a [relatively] well run company, but its PR machine appears to be from Kindergarten land, and the aura of invincibility that it enjoys(ed?) is highly undeserved, as a consequence its historical "aura-based" premium is absolutely unjustified. Case in point...

On December 8th of last year, I penned "Reggie Middleton vs Goldman Sachs, Round 1" wherein I challenged all to take a critical look at exactly how much money was lost by Goldman Sachs' clients. Well, here comes round 2, which is directed at Goldman (over)valuation.

 Three months ago I explicitly warned my readers and subscribers about how outrageously priced Goldman Sachs was: Get Your Federally Insured Hedge Fund Here, Twice the Price Sale Going on Now! Monday, 19 October 2009.. Goldman was closed at $186.10 that day.

Saturday, 30 January 2010 18:00

Reggie Middleton vs Goldman Sachs, Round 2

Before I get started, I want all to realize that this is not Goldman bashing piece. I think it is a [relatively] well run company, but its PR machine appears to be from Kindergarten land, and the aura of invincibility that it enjoys(ed?) is highly undeserved, as a consequence its historical "aura-based" premium is absolutely unjustified. Case in point...

On December 8th of last year, I penned "Reggie Middleton vs Goldman Sachs, Round 1" wherein I challenged all to take a critical look at exactly how much money was lost by Goldman Sachs' clients. Well, here comes round 2, which is directed at Goldman (over)valuation.

 Three months ago I explicitly warned my readers and subscribers about how outrageously priced Goldman Sachs was: Get Your Federally Insured Hedge Fund Here, Twice the Price Sale Going on Now! Monday, 19 October 2009.. Goldman was closed at $186.10 that day.

Well, it looks like Blankein, Dimon, et. al. really should have tried harder to make that meeting with the President a couple of weeks ago. It appeared as if he may have had something important to discuss. As my readers and subscribers know, I have been very bearish on the big money center banks since 2007, and quite profitably so. The last 3 quarters saw a much larger trend reversal than I expected, that resulted in the disgorgement of a decent amount of those profits - a disgorgement that I am still beating myself up over. You see, as a fundamental investor, I don't do well when reality diverges from the fundamentals for too long a period. Luckily for me, fundamentals always return, and they usually return with a vengeance. To keep things in perspective though, I am still up on a cumulative basis many, many multiples over the S&P (which is still negative, may I add) as well as your average fund manager. Why? How was I able to do this? Well, its not because I am supersmart, or well connected. It is because I keep things in perspective. Those that look at the records that I publish say, "Well he was down the last couple of quarters, so..." while disregarding what happened the 8 or even 40 or so quarters before that. Such a short term horizon will probably not be able to appreciate the longer term perspective and foresight that enabled me to see this entire malaise coming years ago and profit from it. No, I am not perfect and I do mess up on occasion, but I also do pay attention to the facts.

These facts pointed to a massive overvalutation in banks throughout the bulk of last year, again! I made it clear to my subscribers that the banks simply have too many things going against them: political headwinds, nasty assets, diminishing revenue drivers, over-indebted consumers, and a soft economic cycle. I also warned explicitly that I didn't think Obama would be nearly as lenient on the banks as Bush was. Well, the headwinds are stiffening. On that note, let's take an empirical look at just what this means in terms of valuation (note, I will following this up with a full forensic re-valuation for all subscribers, incuding a scenario analysis of varying extents of principal trading limits). Some of these banks are I-N-S-A-N-E-L-Y overvalued at these post bear market rally levels considering the aforementioned headwinds. Methinks fundamental analysis will make a comeback in a big way for 2010 as it meets the momentum and algo traders in a mutual BEAR feast on the big investment banks cum hedge funds. I can't guarantee it will happen, but the numbers dictate that it should. We shall see in the upcoming quarters.

We have retrieved information about trading revenues for GS, MS, JPM and BoFA. We have also retrieved some balance sheet data to reflect the trend in investment holdings and the level of leverage, but I will address that in a future post for the sake of expediency. While the banks don't break out the P&L for principal trading, we can sort of back into it. Remember, traders are fed bonuses off of net revenue, not profit.

Well, it looks like Blankein, Dimon, et. al. really should have tried harder to make that meeting with the President a couple of weeks ago. It appeared as if he may have had something important to discuss. As my readers and subscribers know, I have been very bearish on the big money center banks since 2007, and quite profitably so. The last 3 quarters saw a much larger trend reversal than I expected, that resulted in the disgorgement of a decent amount of those profits - a disgorgement that I am still beating myself up over. You see, as a fundamental investor, I don't do well when reality diverges from the fundamentals for too long a period. Luckily for me, fundamentals always return, and they usually return with a vengeance. To keep things in perspective though, I am still up on a cumulative basis many, many multiples over the S&P (which is still negative, may I add) as well as your average fund manager. Why? How was I able to do this? Well, its not because I am supersmart, or well connected. It is because I keep things in perspective. Those that look at the records that I publish say, "Well he was down the last couple of quarters, so..." while disregarding what happened the 8 or even 40 or so quarters before that. Such a short term horizon will probably not be able to appreciate the longer term perspective and foresight that enabled me to see this entire malaise coming years ago and profit from it. No, I am not perfect and I do mess up on occasion, but I also do pay attention to the facts.

These facts pointed to a massive overvalutation in banks throughout the bulk of last year, again! I made it clear to my subscribers that the banks simply have too many things going against them: political headwinds, nasty assets, diminishing revenue drivers, over-indebted consumers, and a soft economic cycle. I also warned explicitly that I didn't think Obama would be nearly as lenient on the banks as Bush was. Well, the headwinds are stiffening. On that note, let's take an empirical look at just what this means in terms of valuation (note, I will following this up with a full forensic re-valuation for all subscribers, incuding a scenario analysis of varying extents of principal trading limits). Some of these banks are I-N-S-A-N-E-L-Y overvalued at these post bear market rally levels considering the aforementioned headwinds. Methinks fundamental analysis will make a comeback in a big way for 2010 as it meets the momentum and algo traders in a mutual BEAR feast on the big investment banks cum hedge funds. I can't guarantee it will happen, but the numbers dictate that it should. We shall see in the upcoming quarters.

We have retrieved information about trading revenues for GS, MS, JPM and BoFA. We have also retrieved some balance sheet data to reflect the trend in investment holdings and the level of leverage, but I will address that in a future post for the sake of expediency. While the banks don't break out the P&L for principal trading, we can sort of back into it. Remember, traders are fed bonuses off of net revenue, not profit.

I have been advocating this limitation for some time.

For those that listen to CNBC pundits knocking the separation of deposit taking entities from trading risk assuming entities, here are some common sense rebuttals.

This proposal would not have stopped the AIG failure

No, it would not have. It would have prevented deposit taking institutions such as Citibank and JP Morgan from trading on a speculative basis with AIG though. Theoretically, it would have allowed those that would have got jerked on the AIG to have sunk or swam on their own accord. We never had to stop AIG, we had to stop the repercussions of what an AIG would have caused.

I have been advocating this limitation for some time.

For those that listen to CNBC pundits knocking the separation of deposit taking entities from trading risk assuming entities, here are some common sense rebuttals.

This proposal would not have stopped the AIG failure

No, it would not have. It would have prevented deposit taking institutions such as Citibank and JP Morgan from trading on a speculative basis with AIG though. Theoretically, it would have allowed those that would have got jerked on the AIG to have sunk or swam on their own accord. We never had to stop AIG, we had to stop the repercussions of what an AIG would have caused.

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