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Why Goldman Sachs Remains An Attractive Stock

Company is joining forces with major rivals for SPReD to reduce costs and increase revenue.

Revenue growth remains a strong focus for the company.

Lower debt leaves room for higher dividends in the future.

Goldman Sachs' (NYSE:GS) decision to join forces with major rivals JPMorgan Chase (NYSE:JPM) and Morgan Stanley (NYSE:MS) for the SPReD initiative is a strong indication of the company's distinct collaboration abilities. The goal of SPReD, which stands for Securities Product Reference Data, is the accumulation of data aimed to assist the banking giants in determining accurate pricing, while reducing individual spending and time on gathering such data. If SPReD is approved by the Federal Reserve, SEC, FTC, and Department of Justice, it is expected to launch within six to twelve months. The data will also be provided to other financial institutions for a fee.

Warren Buffett remains a top holder of GS shares through Berkshire Hathaway with over 12.6 million shares at last measure. Investors love Buffett's backing and it is not likely Buffett will be selling GS anytime soon, adding an element of stability to the GS shareholder base and stock price. Joining Buffett in owning GS shares were hedge funds Lansdowne Partners and Greenhaven Associates with 6.39 million shares and 3.15 million shares, respectively. Both Lansdowne and Greenhaven slightly increased their stakes, by 2% and 1%, respectively, since their last filings.

Greenhaven, like Berkshire, is a fund in the value mold and is known for holding a relatively few number of stocks that its stewards believe are undervalued. In light of the investment by value-focused investors and Insider Monkey's research showing that following these funds' long picks can produce alpha, GS seems like a solid investment. Other funds among the top ten hedge fund holders of GS were Eagle Capital with 2.6 million shares; Pzena with 1.5 million; and AQR with 1.4 million. The largest exit out of a GS position by institutional investors belonged to Global Thematic Partners with the selling of close to 378,000 shares - a relatively small amount compared to the holdings of the aforementioned investors.

Revenue Growth Remains a Strong Focus

2014 revenues reached $34.5 billion with remarkable growth in investment banking (31.2%) and growth in investment management (15.7%) services over the last two years. The upward trend continued in 2015 with Q2 2015 revenues reaching $9.07 billion, backed by strong YoY growth in investment banking (13.4%) and investment management (14.6%). In my view, the company's focus on revenue growth and liquidity risk management is paying off. GS has all the potential to maintain the upward revenue trend going forward, mainly due to its diversity of operations and strong capital position consisting of shareholders' equity and unsecured long-term borrowing (3.7% YoY growth, reaching $257.9 billion from $248.7 billion in Q2 2014).

Lower Debt Leaves Room for Higher Dividends

Although GS's accounts payable have increased 9.8% from 2012 to 2014 ($213.6 billion from $194.5 billion), the company has significantly lowered its short-term borrowings by 44.8% ($278 billion to $192 billion over the same time), suggesting that GS maintains diversified funding sources aiming to further reduce its financial risk, especially during periods that the financial markets experience persistent stress. What I find extremely interesting from an investment perspective is that GS has a D/E ratio well above 2, yet, its payout ratio is half the payout ratio of its direct competitors JPM and MS. I think that this leaves the company much room to grow dividends faster than earnings, considering that GS increases its dividends at a steady rate.

Name

Price ($)1

52wk low

52wk high

Market Cap ($ b)

P/E

EPS

D/E2

Div.

Div. Yield

Payout Ratio

Goldman Sachs

180.38

171.26

218.77

81.44

10.69

16.87

4.66

2.60

1.44%

15.41%

JP Morgan Chase

61.50

50.07

70.61

227.55

11.1

5.54

1.85

1.76

2.86%

31.77%

Morgan Stanley

33.19

30.40

41.04

64.72

16.97

1.96

4.47

0.60

1.81%

30.61%

Sources: Yahoo Finance, Nasdaq, Reuters, CNBC

1. Closing Price of Sep 4

2. D/E is calculated based on the Balance Sheet of 2014

Why I favor GS

I strongly believe that GS remains an attractive investment mainly because it leverages risk in several ways. For instance, the SPReD initiative comes as a strategic decision to reduce costs, while sustaining the level of revenue above $34 billion since 2012, in a period that the financial crisis put pressure on revenue globally. GS's successful cost-cutting initiative is expected to further reduce the company's total operating expenses, which were $22.17 billion in 2014 and 1.3% lower than those in 2013. So, if GS and its major rivals are aiming to leverage their cost savings via a new revenue stream, why shouldn't you jump on the bandwagon?

Following the Fed's approval of GS's revised plan for dividends and share buybacks as part of its participation in the Comprehensive Capital Analysis and Review (CCAR), GS increased its Q2 dividend by 8.3%. Evidently, the company is committed to increase shareholder value using its cash generation know-how.

GS has consistently outperformed JPM, MS, and the S&P 500. Since 1999, GS's stock has returned 143.28%, whereas the S&P has returned 43.60%. Analyst consensus estimates a 4-year average EPS of $21.52, up to 2018, and long-term 5-year growth at an average annual rate of 10.07%. In my view, rising estimates and favorable valuation are likely to push the GS stock price higher and reflect its diversified client base and innovative business strategies. Plus it's always a positive to invest on the side of "The Oracle," Warren Buffett.


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