Is Goldman Sachs a $500 Stock?

Some government officials are trying to make Goldman Sachs (GS) the scapegoat for the financial crisis, and the stream of bad news about the company is driving down its stock price. Does that make it a buy? If my calculations are right, Goldman at $125 could be a four-bagger.

The latest problem the company faces is a batch of lawsuits from aggrieved investors. Six such lawsuits have been filed by parties including individual shareholders and pension funds. The suits charge Goldman with various violations, including "breach of fiduciary duty, corporate waste, abuse of control, mismanagement and unjust enrichment."

While I can't judge the merit of any of these charges, shareholder lawsuits resulting from a drop in the value of a company's stock often lead to cash settlements. And Goldman's stock market value has fallen by about $20 billion since mid-April when the Securities and Exchange Commission's charges against Goldman came to light.

I think the market has overreacted to this news, especially since Goldman isn't facing huge losses. For example, some observers speculate that Goldman's legal fees could total $100 million to handle all the lawsuits. And the cost of settling the Abacus lawsuit might total $45 million, three times the fees that Goldman received on the deal. The combined $145 million represents 0.72% of the $20 billion plunge in Goldman's market value and 0.38% of its $38.3 billion cash balance.

As I wrote recently, the bigger concern for Goldman should be what comes out of an investigation that a director, Rajat Gupta, tipped off a hedge fund about Warren Buffett's $5 billion investment in Goldman preferred stock. But even that is unlikely to harm the company financially. Barring a major loss of customers in the wake of these investigations, Goldman's earnings power appears to be largely untouched.

But How's the Stock?

At least two of my DailyFinance colleagues have weighed in on Goldman's tribulations. Gene Marcial noted that 22 of 29 analysts rate Goldman a buy, presumably believing that the bad publicity will not cause clients to defect. Vishesh Kumar pointed out that the more troubling fact that the public's image of Goldman has become much more hostile.

My take on Goldman is that its stock is becoming a screaming buy. My reasoning is that if a stock trades a price/earnings ratio that is well below its earnings growth rate, then the stock is cheap. And with a price/earnings ratio of 6.14 and earnings expected to grow 20.6% in the next year, Goldman's PEG is way below 1 -- 0.3 to be specific, making it super cheap in my book.

There is no rush to buy the stock at this point since there are likely going to be more bad headlines that will drive the stock down further. If it hits $125, consider buying and then sit back for a bumpy but profitable ride that could quadruple the investment.

How so? If Goldman were fairly valued at a PEG of 1.0, it would be trading at $503 (calculated by multiplying its 20.6% earnings growth rate by Goldman's most recent 12 months' earnings per share of $24.43).

Sure that's quite a high price, but even if Goldman reaches half that level, investors would enjoy significant returns. I am not saying that Goldman will escape without a nick -- just that the market has overreacted.