Buffett Bets Big On Goldman Sachs: Should You?

Andrés is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

As a consequence of the investment Buffett made in Goldman Sachs (NYSE: GS) during the depths of the financial crisis, Berkshire Hathaway now has a big position in Goldman, which Buffett intends to keep in the portfolio for the long term. What does Buffett see in Goldman? Should investors replicate his position?

A Long Term Relationship

Berkshire and Goldman have amended the terms of the warrants that were issued to Berkshire as part of the $5 billion investment that Warren Buffett made in Goldman at the height of the financial crisis. Under the new agreement, Goldman will deliver to Berkshire a number of shares that is equivalent to the difference between the average closing price over the 10 trading days prior Oct. 1 and the exercise price of $115 for the warrants. If the stock remains in the area of $150, where it has been trading over the last weeks, for example, that means that Berkshire is getting a sizable position of nearly 10 million shares of Goldman.

Unsurprisingly, Buffett has made a very profitable move with the Goldman deal, but the fact that deserves some big attention from investors is that the Oracle of Omaha is planning to keep Goldman in Berkshire´s portfolio for the long term. Buffet knows a couple of things about investing, and he is an expert in the financial industry, so when he makes a big move in the sector it may be a good idea to pay attention.

The Last Bad Boy Standing

The investment banking industry has been under heavy consolidation over the last years. Goldman Sachs, Morgan Stanley (NYSE: MS), Merrill Lynch, Lehman Brothers and Bear Stearns used to rule the investment banking business before the crisis, but things have changed dramatically.

While Lehman Brothers ended in bankruptcy, Bear Sterns was bought by JP Morgan (NYSE: JPM) with big help from the Federal Reserve, and Merrill Lynch was acquired by Bank of America.

Goldman and Morgan Stanley found a different solution--they became bank holding companies, which gave them access to cheap funding from the Federal Reserve. They also received TARP money and raised additional funds from outside investors. At the end of the day, Goldman and Morgan Stanley remained as the last standing pure investment banks, although JP Morgan still has a sizable investment banking business.

Goldman Sachs may not be the only investment bank, but it´s certainly one of the biggest players in a consolidating industry. Perhaps more importantly, it seems to be the only company aggressive enough to capture market share and increase profitability in the middle term. While JP Morgan is cutting its risks back and still recovering from the London Whale scandal, Morgan Stanly is definitely on a retreat, aggressively reducing its workforce and cutting exposure to big business areas like bond trading.

Goldman received a lot of criticism when Bloomberg reported the existence of a secretive group called Multi-Strategy Investing - or MSI -  which is dedicated to proprietary trading--this means trading with the bank´s money as opposed to managing orders for its clients.

The existence of this sort of internal hedge fund is not against regulations. MSI reportedly holds its positions for more than 60 days, which makes it compliant under the Volker Rule. Besides, MSI has assets under management of $1 billion, which is fairly low for a bank with almost a trillion dollars in assets. Even if the MSI group is enormously profitable - or unprofitable - it will hardly have a big impact on Goldman´s bottom line.

But this shows that Goldman´s culture is still intact.  While competitors are mostly focused on reducing costs and adapting to a stricter regulatory environment, Goldman is doing so while still looking for ways to increase earnings. Considering that the investment banking industry has plenty of room for recovery over the next years, Goldman´s aggressive attitude bodes well in terms of growth potential and market share expansion.

There is Value in Goldman

The bank is trading at a moderate P/E ratio of 10.3, and it carries a price to book value ratio barely below 1--this is quite attractive by historical standards.

Goldman is in the process of reformulating its capital plan and sending it back to the Federal Reserve for further review. The Fed, however, didn´t object to its dividends and shares buyback proposal, so if things go well Goldman could repurchase 7% of its outstanding shares and pay a 1.4% dividend yield to investors. This would bring the total yield – dividends plus buybacks- to an attractive 8.4%.

Bottom Line

Goldman Sachs is a leading global player in an industry that has plenty of upside room for the next few years, and it has the right attitude to benefit from the opportunities that may arise. In addition to that, the bank is trading at a fairly attractive valuation level. If it’s good enough for Warren Buffett, maybe it´s good enough for you.


Andrés Cardenal has no position in any stocks mentioned. The Motley Fool recommends Berkshire Hathaway and Goldman Sachs. The Motley Fool owns shares of Berkshire Hathaway and JPMorgan Chase & Co.. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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