Financial stocks have been hit hard in recent days due to concerns about an economic recession and declining interest rates. Financials are leveraged to the economy so it is no surprise that they are underperforming the market. Since I do not believe that the global slowdown will infect the US, I am taking advantage of the recent decline in equity prices to buy high-quality names. One attractive opportunity that I am taking advantage of is buying Goldman Sachs ($NYSE).
Goldman Sachs is an incredibly well-run investment bank, as is evident in its ability to navigate through two recessions and be profitable every year since its IPO in 1999. Prior to the financial crisis, Goldman’s stock traded above 2x tangible book value (TBV). However, in recent years its valuation has wavered between a slight discount to TBV and 1.5x TBV.
Bears on the stock justify a low valuation by pointing out that the large banks are under enormous regulatory scrutiny which requires them to hold unnecessarily high levels of capital that impedes their ability to earn a high return on equity. I would counter that the requirements for high levels of capital make them safer and better able to weather a downturn. Therefore, their utility-like returns are deserving of a utility-like valuation of 2x TBV. I believe that the steady profits that the banks earn over time will eventually cause the markets to revalue them.
In the meantime, Goldman Sachs offers a 1.5% dividend and is buying back 5% of its outstanding shares each year for a total cash return yield exceeding 6%. Moreover, by buying Goldman at TBV, investors can get the Goldman Sachs brand name and the intellectual capital of the smartest minds on Wall Street for free. I will track GS here with an initial price equal to Wednesday’s close of $159.00.