Why Now Is the Time to Invest in the Smartest Guys on Wall Street

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

Goldman Sachs (NYSE: GS) has always been one of my favorite companies to follow, but it has been difficult to invest in over the past few years. Unlike most financials, Goldman rebounded rapidly after the financial crisis, only to dive again in late 2011. Shares are up considerably this year, but are still a long way below their pre-crisis $250 share price. Despite the roller-coaster ride, I still believe that Goldman represents the “smartest guys on Wall Street” as they have been referred to, and after pulling back by more than 10% from the 52-week high reached in early June, maybe it is time to take another look. Is this a pullback to take advantage of, or is one of Goldman’s peers a better value?

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Who is Goldman Sachs?

One of the largest and most respected investment banking companies in the world, Goldman has almost $1 trillion in assets. The company operates in four segments, the largest of which is the Institutional Client Services segment, which makes up 53% of Goldman’s revenues. This segment is made up of Goldman’s market-making activities as well as its securities services business.

Other segments include Investment Banking (15% of revenues) which includes financial advisory services as well as the company’s underwriting operations. Investment Management (also 15%) offers investment strategies and advice, as well as a range of services to mutual funds, pension funds, and high-net worth individuals. Investing and Lending (17%) is the most exciting, in my opinion, and includes Goldman’s revenue (or losses) from its proprietary trading and lending activities.

The smartest guys on the street?

Goldman Sachs has a controversial reputation, especially since the financial crisis, but one thing that is universally agreed upon is that Goldman attracts and retains some of the best talent on Wall Street, and they are willing to pay for it. Goldman pays out about 40% of its total revenues in compensation, as they believe that talent recruitment and retention are what will give them a leg up.

During the crisis, Goldman initially profited about $4 billion by betting on a collapse of the subprime mortgage market, but things soured for the firm as the crisis went on. In September 2008, just after Goldman agreed to become a bank holding company, Warren Buffet made a $5 billion investment in Goldman, calling it “a bet on brains.” However, the U.S. Treasury also kicked in $10 billion as part of TARP, and Goldman stirred up major controversy by giving out over $1 billion in employee bonuses in that same year.

The numbers

Despite the rise in share price over the past year, Goldman still trades at a relatively cheap valuation, as do most financials at the present time. Goldman is expected to earn $14.51 per share in 2013, meaning that shares currently trade for just 10.4 times this year’s earnings. The consensus calls for Goldman to increase its earnings to $15.35 and $16.00 over the next two years, as the continuing improvement in the economy should greatly help Goldman’s client-service based businesses.

Alternatives: Morgan Stanley and Nomura Holdings

There are plenty of good choices in the sector right now, as I feel that financials are generally cheap. I just recently posted an article about Morgan Stanley (NYSE: MS), the other big investment bank turned bank holding company. Those who are interested in Morgan Stanley as an investment should read that entire post, but in a nutshell the company trades at a relatively cheap valuation of just 11.8 times earnings with very nice growth projected. I believe Morgan Stanley is less risky than Goldman due to having a less-leveraged balance sheet and relying less on risky revenue streams (like trading).

Nomura Holdings (NYSE: NMR) is a less followed alternative, and is a Japanese financial holding company. Nomura attempted to take advantage of the U.S. financial crisis and acquired Lehman Brothers’ Asian operations for just $225 million. Nomura has many subsidiaries with operations in financing, asset management, trading and brokerage, underwriting, and more. Nomura’s earnings were hit especially hard by the financial crisis, and are just now beginning to rebound, making a P/E analysis meaningless. If the company does manage a real earnings turnaround, this could wind up being the most profitable of the three.

Where could Goldman go?

Goldman is currently trading at just above its tangible book value of $149.45 per share, a significant discount to its peers and historical average. Historically, Goldman has traded between 1.2 and 1.5 times book, so using the midpoint of that gives us a price target of $201.76. Admittedly, this is a stretch, so using their historic P/E ratio of around 12 times TTM earnings this gives us a 1-year target price of $184.20 if the analysts’ projections prove accurate.

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Matthew Frankel has no position in any stocks mentioned. The Motley Fool recommends Goldman Sachs. 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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