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  1. 1. Ticker: GS Goldman Sachs Group, Inc. Sector: Financial Industry: Investment Brokerage- I. Stock Screener National From the recommendations of the economics committee, I wanted to look at a company within the financial sector that Recommendation: could expose us to the M&A part of the industry. I wanted to go BUY for an Investment Brokerage company to accomplish that goal. 125 Shares These are the criteria I used to pick my stock. Pricing Closing Price $214.90 (04/17/07) Industry: Investment Brokerage-National 52-wk High $ 222.75 (02/22/07) Sector: Financial 52-wk Low $ 136.79 (06/14/06) Market Cap: >$5B ROE: As high as possible Stop-Loss $ 195.00 (recomm.) P/E: between 0 & 20 Profit Margin: As high as possible Market Data Using these criteria, the stock screener returned a list of Market Cap $ 87.62 B eight different companies which included TD Ameritrade Total assets $ 838.201 B Holding Corp., Goldman Sachs Group Inc., Morgan Stanley, Trading vol 7.469 M (3mon avg) Lehman Brothers Holdings Inc., Merrill Lynch & Co. Inc., The Charles Schwab Corporation, The Bear Sterns Companies, Inc., Valuation and Nomura Holdings Inc. I decided to go with Goldman Sachs EPS (ttm) $ 21.27 since it fit into the economics committee’s recommendations P/E (ttm) $9.69 and is a solid company with a history of good performance. PEG 0.80 Div Yield 0.68 % II. Company Profile The Goldman Sachs Group, Inc. provides investment Profitability & Effectiveness (ttm) banking, securities, and investment management services ROA 1.23 % primarily to corporations, financial institutions, governments, ROE 33.11% Profit Margin 13.79 % and high-net-worth individuals worldwide. It operates in three Oper Margin 21.15 % segments: Investment Banking, Trading and Principal Gross Margin 27.32 % Investments, and Asset Management and Securities Services. The Investment Banking segment provides financial advisory services, such as advisory assignments with respect to mergers and acquisitions, divestitures, corporate defense activities, restructurings, and spin-offs; and underwriting services, including public offerings and private placements of common and preferred stock, convertible and exchangeable securities, investment-grade debt, high-yield debt, sovereign and emerging market debt, municipal debt, bank loans, asset-backed securities, and real estate-related securities. The Trading and Principal Ryan Tate Investments segment engages in market making, trading of, and investing in fixed income and equity products, currencies, 1
  2. 2. commodities, and derivatives on these products. It also involves in specialist and market-making activities on equities and options exchanges; clearing client transactions on stock, options, and futures exchanges; and making principal investments directly and through funds that the company raises and manages. The Asset Management and Securities Services segment provides investment advisory and financial planning services, and investment products; and offers prime brokerage services, financing services, and securities lending services. As of November 24, 2006, the company operated offices in approximately 25 countries. The Goldman Sachs Group was founded in 1869 and is headquartered in New York, New York.1 1 III. Economic & Industry Environment Goldman Sachs is a leading global investment banking, securities and investment management firm that provides a wide range of services worldwide to a substantial and diversified client base that includes corporations, financial institutions, governments, and high- net-worth individuals. Its business activities are divided into three segments: Investment Banking, Trading and Principal Investments, and Asset Management and Securities Services. The following describes the scope of work involved in each business segment: Investment Banking: Goldman Sachs provides a broad range of investment banking services to a diverse group of corporations, financial institutions, investment funds, governments and individuals. Trading and Principal Investments: Goldman Sachs facilitates client transactions with a diverse group of corporations, financial institutions, investment funds governments and individuals and takes proprietary positions through market making in, trading of and investing in fixed income and equity products, currencies, commodities and derivatives on these products. In addition, they engage in specialist and market-making activities on equities and options exchanges and they clear client transactions on major stock, options, and futures exchanges worldwide. In connections with their merchant banking and other investing activities, they make principal investments directly and through funds that they raise and manage. Asset Management and Securities Services: Goldman Sachs provides investment advisory and financial planning services and offer investment products across all major asset classes to a diverse group of institutions and individuals worldwide and provide prime brokerage services, financing services and securities lending services to institutional clients, including hedge funds, mutual funds, pension funds and foundations, and to high-net-worth individuals worldwide.2 Pretax revenue earned by each business segment in 2006 is broken down as follows: Investment Trading and Principal Asset Management and Banking Inv. Securities Services $1,567M $10,600M $2,438M 2 The last economics committee report indicated that investment banking and brokerage has a positive fundamental outlook on the investment banking and brokerage sub-industry. S&P views this part of the industry as a growth industry and very leveraged to a strong economy. 2
  3. 3. Increased profitability is expected as higher-margin equity capital markets and M&A activities rise from cyclically depressed levels. One of the biggest factors the financial sector has faced within the last several months is the record level of defaults from the sub-prime lending institutions. This has hurt the entire market but especially the financial sector. Goldman Sachs ranks very well overall against its peers. Return on Equity is very strong and growth rates are good for such a large and established company. Combining all aspects of the company makes it a very good company fundamentally. The P/E and PEG ratios rank low in the industry which may be of some concern. GS VS. INDUSTRY LEADERS GS Statistic Industry Leader GS Rank Market Capitalization GS 87.78B - 1 / 21 P/E Ratio (ttm) MKTX 107.55 10.10 16 / 21 PEG Ratio (ttm, 5 yr expected) SCHW 1.77 0.83 11 / 21 Revenue Growth (Qtrly YoY) AMTD 82.20% 22.00% 12 / 21 EPS Growth (Qtrly YoY) KBW 234.10% 31.40% 8 / 21 Long-Term Growth Rate (5 yr) OXPS 22.5% 12.0% 7 / 21 Return on Equity (ttm) OXPS 47.92% 31.16% 5 / 21 Long-Term Debt/Equity (mrq) BSC 17.409 11.864 3 / 21 Dividend Yield (annual) MER 1.60% 0.70% 7 / 21 All competitors within the industry looked good and all had comparable numbers. Margins and net income were strong for all companies from a strong 2006. EPS especially stood out for Goldman Sachs against its competitors which was nearly double than the competitors shown below. DIRECT COMPETITOR COMPARISON 3
  4. 4. GS JPM MER MS Industry Market Cap: 87.62B 173.56B 78.72B 86.50B 981.13M Employees: 30,335 174,360 56,300 55,310 3.95K Qtrly Rev Growth (yoy): 22.00% 22.10% 27.20% 28.60% 32.10% Revenue (ttm): 39.96B 58.17B 32.69B 36.30B 403.33M Gross Margin (ttm): 91.53% N/A 87.95% 93.32% 85.41% EBITDA (ttm): N/A N/A N/A N/A 34.48M Oper Margins (ttm): 39.48% 42.79% 30.43% 37.56% 38.17% Net Income (ttm): 10.09B 13.65B 7.31B 8.42B 53.28M EPS (ttm): 21.269 4.040 7.593 8.098 1.34 P/E (ttm): 10.09 12.37 11.72 10.13 17.37 PEG (5 yr expected): 0.80 1.19 0.93 0.82 0.92 P/S (ttm): 2.11 2.93 2.33 2.32 2.33 JPM = JP Morgan Chase & Co. MER = Merrill Lynch & Co. Inc. MS = Morgan Stanley Industry = Investment Brokerage – National IV. Risks As with most companies that operate in the financial sector and specifically the investment brokerage industry, there are a certain level of risks involved. 4
  5. 5. • Market Risk-Changes in spot rates in the currency market can have an effect on earnings for Goldman Sachs. Other generic risks associated with the market may include interest rates, equity prices, and commodity prices. • Credit Risk-There is the risk as Goldman Sachs lends money to its clients, they may fail to perform under their contractual obligations. Most recently, we have seen how the sub- prime lenders have had a record number of defaults and big financial firms have faced financial hardships and even bankruptcy because of this. Sub-prime lending has caused the biggest scare in the financial sector most recently. • Liquidity Risk-This is a big reason financial institutions fail, because of the inability to generate sufficient revenues to cover debt obligations. V. Financials Income Statement Goldman Sachs had a very strong year financially. Net revenues increased 49% to 37.7 billion and net income rose 70% to $9.5 billion. EPS increase 76% from 2005. While revenues grew 49% in 2006, operating expenses only increased 36% which allowed Goldman Sachs to produce a pre-tax margin of 39% which was a record. They were also able to produce more earnings per dollar of net revenues than any year since Goldman Sachs went public. Balance Sheet Goldman Sachs grew its asset base at a rate of 18.6% to $838.2 billion. Liabilities grew at a slightly smaller rate. An area of concern may be the highly leverage nature of Goldman Sachs. Total Assets are at $838.2 billion while Equity stands at $35.7 billion. Though, Goldman Sachs does have a very strong long-term debt to equity ratio indicating that most of Goldman Sachs borrowings are short term in nature. This does not pose much of a risk to me because this is the nature of the industry and does not pose anything out of the ordinary. Cash Flow Statement The single biggest thing that jumped out at me on the Cash Flow Statement came from Goldman Sachs cash flows from investing activities. In 2005 there was an inflow of $1.06 billion as compared to an outflow of $9.7 billion in 2006. Goldman Sachs tied up a lot of their cash into investing activities which is not necessarily a bad thing. VI. Valuation The first step in coming up with the intrinsic value of Goldman Sachs was to calculate the beta of the company and determine the appropriate discount rate. I used two different methods to come up with beta; the first was the unlevered beta approach as recommended by the portfolio committee at the following website. 5
  6. 6. I used the book value of debt and the book value of equity as well as the effective tax rate off of Goldman Sachs 2006 financial statements to come up with the inputs for the levered beta calculation. The results were as follows: Inputs Tax Rate 0.35 BV Debt 195,474.00 BV Equity 35,786.00 Unlevered Beta 0.34 Output Levered Beta 1.55645503 I also ran a regression of the weekly returns of Goldman Sachs versus the S&P 500 over the past three years. My regression yielded a beta of 1.36. Since the two beta calculations were fairly close to each other I took the average of the two to use in my valuation models. So, a beta of 1.46 was used. For comparison purposes, Yahoo finance came up with a beta of 1.19. Using the beta of 1.46 my cost of equity was figured to be 9.08% based on the formula: Cost of Equity = 1.46(3%) + 4.70% = 9.08% The first valuation model I was Warren Buffet’s Owner’s Earnings Model. I used analysts predictions of future growth over the next 5 years of 12% and a long-term growth rate of 3% for the second stage growth rate. Based on these inputs the intrinsic value of the firm came out to be $543.04. This seems to be a very attractive number but I would not put a whole lot of weight on the outcome of this model. Goldman Sachs had an outstanding year in 2006 and perhaps the numbers used in the valuation of this model gave the inflated value. A sensitivity analysis was performed below. No matter what growth rates are given, according to this model, Goldman Sachs is undervalued. Again, I am not sure how much weight I would put on this model. Initial Growth Rate Long-Term Growth Rate Intrinsic Value 12% 3% $543.04 10% 2.5% $469.86 8% 2% $408.81 6% 1.5% $357.42 4% 1% $313.81 I also used the 2-stage dividend discount model to come up with an intrinsic value for Goldman Sachs. The results were the same such that the value was inflated over where the stock price currently stands. I again used the 12% initial growth rate and the 3% long term 6
  7. 7. growth rate and came up with an intrinsic value of $414.56. I used a 90% weight on outside estimates of 12% growth and 10% weight on the fundamental growth which was at 30.69%. I did not put any weight on historic growth. Again, Goldman Sachs outstanding year and 2006 numbers may be slightly skewing the numbers, making it hard to come up with a true intrinsic value for Goldman Sachs. Sensitivity analysis produced the following results: Initial Growth Rate Long-Term Growth Rate Intrinsic Value 12% 3% $414.56 10% 2.5% $358.63 8% 2% $311.59 6% 1.5% $271.66 4% 1% $237.52 VII. Stock Performance Looking at the stock chart, you can see that Goldman Sachs has been on a big incline since about mid 2005 and even more sharply from the last part of 2006 into 2007. Goldman Sachs hit its 52- week high on 2/22/07 and has recently held pretty close to that number. Over the long-term investment horizon Goldman Sachs has outperformed both the market and industry averages. Technical analysis indicates that Goldman Sachs stock price is well extended over its 300 day moving average which is right around $173 per share. This may bring up concerns from a technical standard that we have seen the stock price move too quickly and are due for a drop in stock price to settle at a more stable number. Recently, it has been staying more closely to its 50 day moving average. 7
  8. 8. VIII. Analysts Expectations RECOMMENDATION TRENDS Three Months Current Month Last Month Two Months Ago Ago Strong Buy 4 4 5 5 Buy 7 8 9 9 Hold 10 9 7 7 Sell 0 0 0 0 Strong Sell 0 0 0 0 Analysts gave a mean rating of 2.3 to Goldman Sachs which is right at a buy for the company. Recommendations have remained relatively steady over the past several months. 8
  9. 9. IX. Recent News I thought that it should be noted that in Goldman Sachs 2006 annual report, they sited that their growth strategy is to look to new and developing markets, particularly in India, Russia, Brazil, and the Middle East. They have been in China since the early 1990’s and have profited greatly from their presence there. They hope to continue their growth through the expansion into these emerging areas. On Monday, April 16, 2007, Goldman Sachs announced their plans to sell as much of 46% of their investment in the Italian cable maker Prysmian SpA in an initial public offering at a big profit. Goldman Sachs bought 92% of the company in 2005 for EUR490 million and expects to raise as much as EUR1.17 billion. Shares went up $8.01, or 3.9% on Monday afternoon trading. On April 9, 2007, Goldman Sachs won a big to advise on the merger of Emirates Bank Group and National Bank of Dubai that will create the U.A.E.’s largest lender with assest of about $45 billion. X. Recommendation I would recommend buying 125 shares of Goldman Sachs. The economics committee was high on this area of the financial sector and all signs point to strong M&A activity into the near future. Goldman Sachs had a record year in terms of margins and earnings and posted a record first quarter of 2007. I like their strategy for continued growth, getting into emerging markets such as India, Russia, and Brazil which is also one of our goals for the fund as far as international growth. I believe this could be one of the strongest stocks in the financial sector of our portfolio. Goldman Sachs is a strong company and has a good history of earnings and growth. So therefore I recommend buying 125 shares at the current stock price of $214.90. My stop loss recommendation would be around $195.00. Our risk to capital would be 0.19% as shown below. (214.90-195) *125/1,297,794.65 = 0.19% 9
  10. 10. XI. Appendices *All numbers in thousands INCOME STATEMENT PERIOD ENDING 24-Nov-06 25-Nov-05 26-Nov-04 Total Revenue 69,353,000 43,391,000 29,839,000 Cost of Revenue 18,987,000 13,728,000 11,282,000 Gross Profit 50,366,000 29,663,000 18,557,000 Operating Expenses Research Development - - - Selling General and Administrative 3,424,000 2,612,000 2,308,000 Non Recurring - - - Others 694,000 625,000 685,000 Total Operating Expenses - - - Operating Income or Loss 46,248,000 26,426,000 15,564,000 Income from Continuing Operations Total Other Income/Expenses Net - - - Earnings Before Interest And Taxes 46,248,000 26,426,000 15,564,000 Interest Expense 31,688,000 18,153,000 8,888,000 Income Before Tax 14,560,000 8,273,000 6,676,000 Income Tax Expense 5,023,000 2,647,000 2,123,000 Minority Interest - - - Net Income From Continuing Ops 9,537,000 5,626,000 4,553,000 Non-recurring Events Discontinued Operations - - - Extraordinary Items - - - Effect Of Accounting Changes - - - 10
  11. 11. Other Items - - - Net Income 9,537,000 5,626,000 4,553,000 Preferred Stock And Other Adjustments (139,000) (17,000) - Net Income Applicable To Common Shares $9,398,000 $5,609,000 $4,553,000 BALANCE SHEET PERIOD ENDING 24-Nov-06 25-Nov-05 26-Nov-04 Assets Current Assets Cash And Cash Equivalents 87,283,000 61,666,000 52,544,000 Short Term Investments 82,126,000 83,619,000 44,257,000 Net Receivables 96,022,000 75,381,000 52,545,000 Inventory - - - Other Current Assets - - - Total Current Assets - - - Long Term Investments 556,667,000 474,534,000 371,686,000 Property Plant and Equipment 6,990,000 5,097,000 4,083,000 Goodwill 3,184,000 3,148,000 3,182,000 Intangible Assets 2,502,000 2,055,000 1,689,000 Accumulated Amortization - - - Other Assets 3,427,000 1,304,000 767,000 Deferred Long Term Asset Charges - - 626,000 Total Assets 838,201,000 706,804,000 531,379,000 Liabilities Current Liabilities Accounts Payable 227,706,000 192,386,000 164,201,000 Short/Current Long Term Debt 351,201,000 353,316,000 234,629,000 Other Current Liabilities - - - 11
  12. 12. Total Current Liabilities - - - Long Term Debt 195,474,000 123,338,000 100,090,000 Other Liabilities 23,275,000 6,598,000 5,571,000 Deferred Long Term Liability Charges - - - Minority Interest 4,759,000 3,164,000 1,809,000 Negative Goodwill - - - Total Liabilities 802,415,000 678,802,000 506,300,000 Stockholders' Equity Misc Stocks Options Warrants - - - Redeemable Preferred Stock - - - Preferred Stock 3,100,000 1,750,000 - Common Stock 6,000 6,000 6,000 Retained Earnings 27,868,000 19,085,000 13,970,000 Treasury Stock (21,230,000) (13,413,000) (6,305,000) Capital Surplus 19,731,000 17,159,000 15,501,000 Other Stockholder Equity 6,311,000 3,415,000 1,907,000 Total Stockholder Equity 35,786,000 28,002,000 25,079,000 Net Tangible Assets $30,100,000 $22,799,000 $20,208,000 STATEMENT OF CASH FLOWS PERIOD ENDING 24-Nov-06 25-Nov-05 26-Nov-04 Net Income 9,537,000 5,626,000 4,553,000 Operating Activities, Cash Flows Provided By or Used In Depreciation 995,000 854,000 624,000 Adjustments To Net Income 2,149,000 1,306,000 2,264,000 Changes In Accounts Receivables (1,794,000) 1,322,000 (776,000) Changes In Liabilities 26,862,000 82,196,000 36,669,000 Changes In Inventories - - - Changes In Other Operating Activities (85,366,000) (103,717,000) (76,946,000) 12
  13. 13. Total Cash Flow From Operating Activities (47,617,000) (12,413,000) (33,612,000) Investing Activities, Cash Flows Provided By or Used In Capital Expenditures (1,744,000) (1,421,000) (608,000) Investments (6,412,000) 274,000 - Other Cashflows from Investing Activities (1,592,000) 83,000 (255,000) Total Cash Flows From Investing Activities (9,748,000) (1,064,000) (863,000) Financing Activities, Cash Flows Provided By or Used In Dividends Paid (754,000) (511,000) (497,000) Sale Purchase of Stock (4,992,000) (4,246,000) (1,284,000) Net Borrowings 58,679,000 23,070,000 33,534,000 Other Cash Flows from Financing Activities 464,000 1,060,000 - Total Cash Flows From Financing Activities 53,397,000 19,373,000 31,753,000 Effect Of Exchange Rate Changes - - - Change In Cash and Cash Equivalents ($3,968,000) $5,896,000 ($2,722,000) 13