The Goldman Sachs Group (NYSE:GS), the iconic Wall Street investment bank, is down 13% on a year-to-date basis but is flat over the past year. But GS stock is set to be a gold medal winner in the investment world.
Earnings are set to rebound and as economic activity picks up its return on equity will skyrocket. I estimate investment in GS stock will make at least 27% for the next two years.
Goldman’s Q3 earnings will be out in the next two or three weeks. Analysts polled by Yahoo! Finance expect earnings per share (EPS) to reach $4.96 this quarter. That works out to a run rate of $19.84 on an annual basis.
That means GS stock is very cheap at today’s price around $208. At 10 times earnings (i.e., $201.80 divided by $19.84) the stock looks like a bargain.
Moreover, these analysts are predicting EPS of $22.69 for next year. That gives GS stock a forward P/E ratio of just 8.9 times earnings. That is super cheap.
GS Stock Is a Good Earner
Analysts who cover the financial sector love Goldman Sachs. They see the company as more than just a financial macroeconomic recovery story.
As one analyst put it: “the management team has multiple initiatives in place in both incumbent businesses and new areas to drive multi-year revenue growth.”
For example, Goldman has been moving deeper into a new area – consumer credit cards. As the Wall Street Journal reported on Oct. 1, Goldman beat out Barclays to run the GM credit card business. They paid $2.5 billion for a card that generates about $8.5 billion in credit card spending.
The way they make money is interest and fees on this business. In general, this tends to be a high margin business.
For one, Goldman can leverage their funding of the credit card balances. Second, they can sell off the monthly credit card loans in secondary markets, usually at a premium.
And third, I suspect these credit cards have low loan losses, as the people who own these cards likely pay their car payments on time as well.
A Return on Equity Performer
As of June 30, 2020, the company’s tangible book value per share (TBVPS) was $206.43 per share, according to Seeking Alpha. Therefore, going forward, assuming Goldman Sachs made $22.69 in earnings, its return on equity will be 11.0% in 2021.
That is a very respectable return. By the way, note that the stock price today, at $201.83 is below the $206.43 TBVPS.
Therefore you are buying its book value at a slight bargain. It also means that you get a return on TBVPS at a bargain as well. The net effective ROE is therefore 11.24%.
Moreover, the investment bank is set to lay off about 1% of its workforce, according to Reuters, in a measure to increase its efficiency. That will feed through to its earnings per share and return on equity in the long run.
In other words, laying off personnel that it considers unnecessary for some reason increases its shareholder returns. That is how capitalism works.
A profitable company is always looking to get more profitable, even to the point of rationalizing its workforce which produced those profits.
The bank’s main source of revenue and profits is its fixed-income trading business. This makes it stand out from its major money center bank competitors. It also helps the company make money even in down markets like the past several quarters.
What to Do With GS Stock
Goldman’s diversity and consistency in earnings are one of the reasons the stock has not been hit as bad as some of its competitors. Moreover, the stock is unduly cheap right now.
For example, it is very rare to be able to buy a company making greater than 10% return on equity at a price below tangible book value and below 10 times earnings.
And, of course, don’t forget the dividend. Although it looks like the Fed won’t allow banks to raise their dividends yet, or to buy back their shares, the dividend yield is still attractive.
Its $5.00 annual dividend per share yields 2.48% today. But, according to Seeking Alpha, the stock’s four-year average yield is 1.59%.
Therefore, if GS stock was to move higher to attain this yield with its $5.00 dividend, the target price would be $314.47 per share. This is because if you divide $5.00 by 1.59% you get $314.47. This represents a potential gain of 55.8% over today’s price of $201.80 (Oct. 5).
That is a very reasonable ROI for an investor in GS stock. Even if it takes two years to achieve, the compound average return would be 24.8% per year over the next two years. Combined with the 2.48% dividend yield, the total expected return on investment in GS stock is 27.3% annually.
On the date of publication, Mark R. Hake did not have (either directly or indirectly) any positions in any of the securities mentioned in this article.