While many investors were in fear mode in September 2008, Berkshire Hathaway’s (NYSE:BRKA) Warren Buffett saw opportunity. He made a $5 billion investment in preferred shares of Goldman Sachs (NYSE:GS). He also received warrants to purchase an additional $5 billion in stock, with an exercise price of $115 a share.
It certainly was a savvy deal. This week, Buffett got a $5.5 billion payment from Goldman to pay off the preferred stock position. Interestingly enough, he didn’t want the money — he was getting 10% dividend on the investment.
While Goldman is in much better position now, there is still some skepticism about the stock (although Buffett says he will not exercise his warrants until the last day of expiration, which is in about two years).
Let’s take a look at the pros and cons:
Pros
Best-of-breed. There is no doubt that Goldman has a rigorous selection process when recruiting employees — it’s not uncommon to have several dozen interviews before there is a hiring decision. The firm understands that it is nothing without its people.
Where individualism is rampant on Wall Street, Goldman takes a team approach. Over time, the result is that the firm has been able to beat out tough competitors like Morgan Stanley (NYSE:MS), Bank of America’s (NYSE:BAC) Merrill Lynch and JPMorgan Chase (NYSE:JPM).
Deal machine. Since the financial crisis, Corporate America has substantially reduced mergers and acquisitions (M&A). But this is starting to change. Many companies have huge amounts of cash and realize there are opportunities to grow through deal-making. This will mean juicy fees for Goldman.
It also looks like initial public offerings are perking up. And there are a group of fast-growing companies, such as Facebook and Groupon, that will need the advisory services of Goldman.
Risk management. Goldman certainly engages in high-risk investments. Yet over the decades the company has built a strong risk-management culture. It has helped the company deal with tough economic environments and even the financial crisis.
Cons
Black box. Goldman has an extremely complex business (just try reading through the SEC disclosures), with procedures and strategies that are fairly opaque. This is certainly by design since Goldman wants to keep such things proprietary. But it makes it tough for investors to analyze the company.
Conflicts. As Goldman has grown, it has had troubles with conflicts of interest. For example, last week Congress released a 640-page report about Goldman’s mortgage business. The claims are that the firm sold toxic securities to its clients and even shorted them.
Regulations. To get access to cheap financing from the Federal Reserve, Goldman became a bank holding company in late 2008. It was a smart move. But it will mean more oversight and higher capital requirements. Because of this, returns are likely to be lower.
Verdict
Despite having to take a $1.64 billion charge for the payback of Buffett’s investment, Goldman was still able to post a profit of $2.74 billion in the latest quarter. The firm continues to generate strong gains from its trading activities, especially in bonds and equities. This was the case even though it was a choppy environment.
But Goldman always seems to be able to find a way to adapt — and find success. True, the firm will need to deal with liability exposures from the financial crisis as well as new regulations. However, these should be manageable.
The fact remains that Goldman is a top-notch global financial firm, which should benefit from increased deal-making, trading activity and asset management. All in all, the pros outweigh the cons on the stock.
Tom Taulli’s latest book is “All About Short Selling” and his Twitter account is @ttaulli. He does not own a position in any of the stocks named here.
