Inside Wall Street: The Goldman Bulls Are Hanging Tough

Goldman Sachs Building 85 Broad St.
Goldman Sachs Building 85 Broad St.

Even as Goldman Sachs (GS) is grappling with a congressional inquiry and the Securities and Exchange Commission's civil suit accusing it of securities fraud, Wall Street is almost unanimous in its support of the largest and, at least recently, the most profitable investment bank. None of the 29 Street analysts who track Goldman recommend selling the stock. In fact, 22 continue to rate it a buy, and seven others peg it a hold, or neutral.

Such steadfast bullishness isn't surprising, since Goldman is one of the financial world's most consistently successful money machines, often exceeding analysts' sales and earnings forecasts. And its stock has been a big winner over the years, zooming to a 52-week high of $193.60 a share on Oct. 14, 2009, from a 52-week low a year ago of $119.34. The stock traded as low as $47 in 2008.

When the SEC filed its civil suit on April 16 against Goldman, the stock quickly tumbled, to $160 from $184 the day before. It has since dropped some more, closing at $152 on Monday, Apr. 26. And on Tuesday, during the trading day that Goldman execs were getting grilled on Capitol Hill, investors reacted by pushing the shares back up by $1.01, or 0.66%, to $153.04 -- even though the Dow was shedding more than 200 points because of the spreading debt crisis in Europe.

Now Undervalued?

Clearly, the harsh light thrown onto Goldman hasn't fazed the analysts, who are staying with their bullish stance. Among the stock's proponents, according to a Bloomberg survey, are Bank of America Merrill Lynch, Citigroup, Societe General, UBS and Credit Suisse. Those in the neutral camp include JPMorgan Chase, Barclays Capital and Meredith Whitney Advisory Group.

The SEC's accusation of securities fraud involves the structuring and selling of CDOs (collaterized debt obligations) linked to subprime home mortgages. One would think that the SEC case alone would prompt some hesitation on the bulls' part and lead them to reexamine their position. That hasn't happened. In fact, the stock's price drop has tended to convince some analysts that Goldman has become more undervalued, regardless of the SEC complaint.

One element of the bullish case is the steadfast support Goldman is getting from its clients, who continue to do business with the bank. "So far, none of Goldman's major clients have walked away from the firm," says Richard X. Bove, banking analyst at Rochdale Securities. Rove is one of the analysts who continue to rate Goldman a buy. "I am maintaining my 12-month target price of $200 a share," he says, based on Goldman's strong business fundamentals. Clients aren't walking away because "there's no other place to go" that would have Goldman's experience, expertise and resources, he says.

"It took Goldman decades to build what it has now," says Bove, so its clients, including underwriting customers, "aren't upset with Goldman, and they continue to recommit their business to Goldman." The bottom line is, "if Goldman doesn't lose customers, it will continue to prosper," he asserts.

Reputational Risk Is High

Analyst Matthew Albrecht of Standard & Poor's (S&P isn't included in the Bloomberg poll), who rates Goldman a hold, warns that the bank's legal reserves will have to rise in the wake of the SEC suit, and that "could hurt future earnings." But he thinks the firm's reputation faces a greater risk, so Goldman has to reassure clients that it holds employees to the highest ethical standards.

Due to the uncertainty surrounding the SEC suit and potential new regulations on the financial industry, "we think the shares deserve to trade at a smaller premium to peers than they have historically," argues Albrecht. "We would not add to positions." He figures that Goldman's earnings will drop to $20.79 a share in 2010 from 2009's $22.13. For 2011, Albrecht forecasts earnings of $22.10.

If Goldman has strong prospects, is it a good buy now that the stock has dropped sharply?

If Sentiment Shifts

James Jan Sullivan, analyst at investment research outfit Value Line, says it isn't timely to invest now because the government's still-unknown final plan to regulate the financial services industry "is causing uncertainty." Besides, he adds, "some of the three- to five-year capital appreciation potential is already reflected in the stock's price," notes Sullivan. (Value Line isn't included in the Bloomberg's survey).

Normally, I would favor investing in the stock of a highly profitable star that has dropped sharply. But the new inquiries into Goldman's operations could spark a wider probe and traumatize investors. How long it'll take Goldman to get beyond its current woes is difficult to ascertain. The firm's ability to mint profits is so far unquestioned. But the SEC complaint and the proposed overhaul of the financial system could inject some toxicity to Goldman's stock.

And what would happen if the Street's currently bullish analysts start turning bearish on Goldman?