The answer: Goldman Sachs.
This weekend’s financial papers well plastered with articles about the blockbuster Alibaba IPO. But before we get to that you should know that I never invest with highflier stocks such as the ones mentioned on the title. It’s just too risky — an investor who participates in those IPOs pays both for rosy cash-flow projections far in the future and what many people sometimes forget, he pays also for generous future stock market valuation. What do I mean by that? Suppose that you bought Facebook at a PE ratio of 90 expecting it to triple its cash-flow four years down the road, paying “only” 30 times for its three-years-later cash-flow. To succeed with that investment you need Facebook to both triple it’s cash-flow AND maintain a highflier stock multiple. For if it “only” triples its cash-flow but receives a PE of 20 after three years, the investor still stands to lose a lot of money.
Sure, some companies can perform extremely well, deliver better-than-expected results and receive an even more cheery stock market valuation. However, I don’t want to risk my money on such bets because the chances of losing money under almost any scenario turn me off.
But I love investing in companies that enjoy a good franchise, ran by highly talented and devoted people and I like to buy those business at reasonable, or even better, low valuations. The problem is that such businesses’ stocks don’t go on sale too often so one has to be very patient and wait for an opportunity to show itself. Fortunately, even great businesses sometimes get caught in the eye of the storm once in a while. During such times, the investing public — usually suffering from severe myopia — becomes overly pessimistic and throws good stocks at almost any price. Such was the case with Goldman Sachs in late 2011.
Buying a lot of Goldman Sachs for half the tangible book value at under four times its potential earnings during the Occupy Wall street protests was something I couldn’t resist. I just couldn’t get enough of it.
Seeing those tech IPOs done at high valuation just makes me smile because I know that I’m making money of it, without putting my money on the line behind those tech names. If history is any guide, ten years from now some of the companies that are mentioned on the title of this post will probably be worth a fraction of what they are worth today, but Goldman will keep on increasing its book value per share by 15% a year as it has done for the last 15 years (and probably many years before of which we have no public record.)
Back to 2011, thoughts about Goldman
Goldman made a bundle on the Alibaba IPO but although its a lot of money, it is small compared to its total quarterly revenue. However, tomorrow there will be another Alibaba and another Facebook and another Twitter or LinkedIn. Some of these companies will need to issue debt, get help in trading fixed income instruments or maybe even a bankruptcy or restructuring advice and Goldman will be there to serve them — and get a fee for that service.
Here are some things we wrote about Goldman in our 2011 year-end letter to partners:
The stock purchase that excited us the most this year was that of GS. The investment bank that was founded in 1868 is one of the best businesses in the financial sector. Goldman Sachs proved that it can withstand hardships: the great recession of 1929, the 70’s recession and high inflation, the tech-stocks bubble burst and the recent financial crisis. … Today the company trades for $44bn. This is a company that earned $13bn pre-tax last year. In addition, the competitive landscape has changed over the last three years. Two big competitors disappeared (Lehman and Bear Sterns) and other competitors such as Merril Lynch got merged into other entities.
The financial sector got beaten up the most during 2011. We find opportunities in great businesses in this sector. Going forward, we have no doubt that without strong banks and investment banks the economy can’t grow. … Wells Fargo and Goldman Sachs are highly profitable businesses even in the current environment and we have no doubt that the stocks of those two business will outperform over the next few years.
It is always a risk to write something like that in times like the end of 2011, but we got lucky. We wrote even more about Goldman on our mid-2012 letter to partners:
Let’s go back in time to 1999. Optimism is at its peak, stocks have been going up for about a decade, and companies are making more and more money every year. Goldman Sachs makes a lot of money too. Prices in the markets are high and investors are very happy. At this point, imagine that a fortuneteller lets you take a peek into the next decade. Here is what the fortuneteller is saying to you in 1999: In 1.5 years the tech bubble will burst, prices in the stock market will collapse and the number of deals will slow down. Manhattan will be attacked by terrorists and America will enter a couple of wars… In the same time, interests rates in the US will go down and an immense real estate bubble will evolve. As a result, there will be a severe financial crisis, the worst since 1929. Many big companies will fail and go bankrupt. It will be a lost decade for the stock market. After hearing this “prophecy” (remember, now it’s 1999) you are reading in the newspaper that Goldman Sachs will sell its stocks to the public. Given that you know what is about to happen in the coming years, would you have bought Goldman’s shares? Probably not. Who would want to hold an investment bank before a lost decade? Alas, those who didn’t buy probably made a mistake.
Goldman’s book value in 1999 was $10B. Today, at the bottom of the economic cycle Goldman’s book value is $70B. Goldman’s revenues in 1999 were $5.6B and today the revenue is about seven times that number. The market is very pessimistic about Goldman’s future. But,throughout all its 140 years of existence, Goldman has successfully dealt with many challenges and has proven that it knows how to adapt and make money over time. The company is traded very cheaply relative to its intrinsic value and earning power. In our opinion, the market is very shortsighted about GS.
I still like Goldman at the prices it currently trades for and I see a lot of upside going forward. However, one has to bear in mind that an investment with Goldman is no longer the no-brainer that it was back in the end of 2011.
Goldman’s next annual report will be released in early 2015 and I will try to review it here on the blog. I also have a feeling that we will write about Goldman again in the 2014 year-end letter so stay tuned.