In the midst of a bear market, I'm investing in stocks of companies that are already discounting a recession, can weather economic weakness, and are leaders in their field -- stocks to own on the other side of this downturn.
Recession fears have created value opportunities in the financial sector with concerns about loan losses, capital markets, and underwriting fees. Goldman Sachs (GS) currently trades over 10% below its book value, historically an opportune time to buy the stock.
Shares of Goldman are down over 25% this year and trade with a P/E of 7x and a dividend yield of 2.8%. Historically, the stock trades lower and becomes cheap when concerns about Goldman's inherent risks prevail.
In an economic environment of aggressively rising rates and deteriorating credit conditions, Goldman's write-downs and losses can escalate. Recently issued loans for leveraged buyouts are reportedly still on the books at major financial institutions, including Goldman's, and are likely to generate losses.
The rapid move down in the bond market, especially in lower-grade credit, undoubtedly has caused some dislocation. Also, investment banking revenue has weakened as market conditions impact underwriting. Capital markets have closed to initial public offerings of stock, and higher bond yields have slowed new bond deals.
Nevertheless, Goldman doesn't get enough credit for its business quality, durability, and profitability. At Bernstein's Strategic Decisions Conference earlier in June, Goldman's management laid out an impressive path for asset and wealth management growth.
Volatile markets draw in new customers to Goldman, making their goal of double-digit growth in fee income to $10 billion by 2024 more likely. Out-investing competitors in implementation of new technology is helping Goldman continue to gain share and improve firm-wide synergies.
When the stock trades below book, buybacks have an outsized impact on valuation. In the last decade, fully diluted shares have fallen by 37%, from 556 million to 348 million, and book value has more than doubled. Just since 2020, book value is up by 34%. Outside of a severe recession, buybacks will likely continue and book value will increase from Goldman's durable profitability.
According to Jefferies, Goldman, Morgan Stanley (MS) , and Wells Fargo (WFC) were relative winners in the Fed's stress test outcome released on Thursday. They note, current CET1 ratios put them close to internal targets and estimated requirements.
Understandably, Wall Street has a long memory of the financial crisis along with the dilution and counter-party credit risks that Goldman undertakes. However, worries are overdone, in our view, with far less leverage in the system and Goldman's diversification, including $2.7 trillion in assets under supervision. The firm is trending toward fee-based income and away from balance sheet risk. In a difficult first quarter, Goldman earned $3.9 billion with a 15% ROE.
Although there have also been dramatic declines in fundraising in capital markets, M&A has maintained strength. Goldman leads the league tables in advising on merger deals.
Sometimes the best house in the neighborhood is on sale, and it pays to be a buyer in tough times.
Goldman is diversifying, gaining share, and attracting new fee-based business throughout these challenging markets. The buying opportunity below book value is compelling for this financial markets juggernaut.