Buying Goldman stock will put you in good company
Paul Sullivan
RTGAM






Here's a good question: Should you invest in Goldman Sachs Group Inc. ?

It would be easy to answer "no," and just keep on walking, your hand wrapped around your wallet, as no Wall Street firm has come to symbolize the decline and fall of the American financial system more than Goldman Sachs.

CEO Lloyd Blankfein and the company he heads have been universally vilified for making out like a bandit while ruining thousands of unsuspecting customers by pushing dubious mortgage products while betting against them. While admitting no wrongdoing, Goldman Sachs agreed to pay a $550-million (U.S.) settlement to the U.S. Securities and Exchange Commission on July 15. Mr. Blankfein did eat a thin slice of humble pie by admitting the company made a mistake in marketing the subprime product called Abacus 2007-AC1 with less than complete information.

That "less than complete information" was the staggering omission that hedge fund manager John Paulson was involved in selecting the securities for the product while intending to bet against them by selling them short!

Is this the kind of company you'd want to invest in?

Well, strictly by the numbers, Goldman Sachs looks like a pretty good stock.

Its Q2 profits are down 82 per cent over the same period last year, but they are still $613-million, even after Goldman Sachs was required to pay a $600-million in British tax on bankers' bonuses. The stock is trading south of $150, which is comparatively cheap, considering the fact it was at $185 before the SEC launched its suit against the company on April 16, 2010.

And look who is buying Goldman Sachs stock:

The Bill and Melinda Gates Foundation, the world's largest philanthropic foundation, bought 500,000 shares in Q2.

Warren Buffett's Berkshire Hathaway famously bought $5-billion in Goldman preferred shares at the bottom of the 2008 financial meltdown, and acquired warrants for another $5-billion. Charlie Munger, Berkshire's vice-chairman, commented that "we felt their merits outweighed their defects."

While its reputation may have suffered irreparable damage through the mortgage meltdown, the company is also the target of grudging respect for navigating its way through the treacherous shoals better than other Wall Street institutions such as Merrill Lynch, which collapsed into the arms of Bank of America and Lehman Brothers, which simply collapsed.

And the darnedest thing is, smart people such as Bill, Melinda and Warren are still investing. Even the notorious John Paulson, he of the Abacus scandal, bought 1.1 million shares of Goldman Sachs in Q2. Mr. Paulson wasn't part of the SEC suit against Goldman Sachs, as he did nothing wrong, unless you think betting against a fund you help design is wrong.

A lot of people think that Goldman Sachs is really in the business of enriching its employees. It's hard to argue against that charge as the company has already set aside 43 per cent of its year-to-date revenue - $9.3-billion - to pay salaries, benefits and year-end bonuses. And that's down from $11.4-billion or 49 per cent last year.

As the 655th richest man in the world, star trader Leon Cooperman, is famously quoted as saying: "I determined many years ago that if you want to make money on Wall Street, you work there; you don't invest there. They just pay themselves too well."

It's all true, obviously, but as Goldman Sachs continues to respond profitably to the stomach-churning fluctuations in the market, you have to understand the attraction.

The source of most of its profits and revenue indicate that Goldman Sachs has strayed far from its long-term role as an investment banker. In 1998, 40 per cent of its revenue came from investment banking; in the third quarter of 2009, that number had dwindled to 7 per cent, while trading and principal investments rose to 81 per cent. And the lion's share of that came in fixed income, currency and commodities.

Some contend that any idiot could make money by riding the current yield curve, and in the words of Charlie Munger, many idiots do. Morgan Housel of the Motley Fool.com contends that Goldman Sachs traders are able to borrow money at zero per cent and invest it in riskless securities at 3 to 4 per cent. In other words, they're not really earning their average salary of $500,000 a year.

Why, you wonder, don't the shareholders get some of that free money? In 2009 Goldman shares paid an annual dividend of $1.40, or 0.94 per cent, which is not bad if you own a million of them, but the dividend is hardly worth the ante, or the risk.

You have to wonder how long the U.S. and its principal financial bastion can continue to ride the wave of cheap money. Washington has spent trillions to keep its economy above water; unemployment is above 9 per cent yet Lloyd and the boys continue to collect rich bonuses. What's wrong with that picture? Still, Goldman Sachs' hard-headed realism has proven consistently capable of taking the economic lemon and turning it into lemonade. Let's not forget that while the U.S. Treasury lent Goldman Sachs $10-billion in October, 2008, it was the first U.S. financial institution to pay the Troubled Asset Relief Program (TARP) back - with 23 per cent interest.

While other U.S. investment banks were throwing their best practices overboard to be like Goldman Sachs, leading to their ruin, Goldman stayed consistently alert. These days, as others cling to the hope that the recession is over, its principal economist Jan Hatzius is warning that the U.S. economy will slow down in the second half of the year and the risk of deflation - a decrease in wages and prices- is real.

When Mr. Hatzius speaks, Wall Street listens, as he's ranked the Number One economist on Wall Street, according to The New York Times, and is the recent recipient of an award from Arizona State University for his "uncanny economic forecasting that anticipated the global financial crisis." With Jan Hatzius calling the shots, Goldman Sachs is less likely to make the kind of mistakes that have sunk so many of its rivals.