Does Goldman Sachs Group Inc. Deserve its Place on the Dow?

It's the world's most recognizable investment bank, but are the Goldman Sachs bubble machine's best days behind it?

Jun 20, 2014 at 12:00PM

The Dow Jones Industrial Average (DJINDICES:^DJI) has been America's most-watched market index for decades, despite -- or perhaps because -- of its narrow focus on a mere 30 stocks. Where other indices might track 500, or 2,000, or even 5,000 different stocks, the Dow's steady focus on 30 business bellwethers has made it both easier to understand and easier to dismiss as a relic of simpler times. But as long as the Dow remains front and center in every day-to-day market analysis, it and its component companies will remain the most important barometers of American markets.

Gslogo

Source: Wikimedia Commons.

That's why it's important to understand not only the Dow, but its components as well. What do they do? What do they represent on the Dow, and why do they matter to the American economy? Where have they come from and where might they be heading in the future? Today we'll dig into the details of Goldman Sachs (NYSE:GS) to find answers to these questions and more, so that we can understand not just what moves the Dow, but why.

Goldman Sachs at a glance

  • Founded: 1869. 
  • Joined the Dow: Sept. 20, 2013. 
  • Current Dow weighting: 6.5% (3rd out of 30 stocks).
  • Replaced: Bank of America due to low share price. 
  • Sector represented: Financials (investment banks).
  • Rank (by revenue) among all financial stocks:
    • o 5th (Fortune 500, commercial banks)
    • o 2nd (Forbes Global 2000, investment services)
    • o 1st (Marketwatch, by mergers and acquisitions volume)
    • o 6th (Tricumen, by revenue from equity derivatives)
    • o 1st (Tricumen, by revenue from equity trading)
    • o 1st (Tricumen, by revenue from proprietary trading)

Love it or hate it (and most people have chosen the latter), investment bank Goldman Sachs has been an important -- and infamous -- part of the global financial industry for decades.

The firm first rose to prominence during the Roaring 20s as a promoter of "investment trusts," which were opaque and thinly capitalized trading vehicles that Goldman daisy-chained together until a modest decline in market values could wipe the whole chain out. Since the Great Depression's decline was anything but modest, Goldman's investment trusts alone were responsible for detonating more than $1 billion in total market value. This might not seem so outlandish today, but the total value of all stocks on the New York Stock Exchange was only $90 billion at the time the market peaked in late 1929.

Goldman's strength faded with the rest of Wall Street following the crash and subsequent New Deal reforms, but by the 1970s it was again on the upswing under the guidance of Gustave Levy, the partner credited with creating the company's "long-term greedy" mantra. Goldman was a driving force behind the major financial trends of recent decades, riding the mergers and acquisitions boom to billions in profit during the 1980s and cashing in on the IPOs of many of the hottest tech companies during the 1990s. These two lines of business continue to be major profit centers for Goldman today -- the company in 2014 had its advisory hands in a stunning 362 global M&A transactions worth $718 billion, and it also earned $1.7 billion in revenue from underwriting fees last year for helping take other companies public. Since early 1997, Goldman has helped underwrite more than 850 IPOs, according to data compiled by the Nasdaq exchange.

As a major player in the derivatives market, Goldman found itself in the middle of the anti-banking firestorm that erupted following the global financial crisis. Millions of Americans became aware of Goldman's role in the crisis as a torrent of incendiary articles by Rolling Stone's Matt Taibbi and other popular journalists exposed some of the company's shadier practices. The credit default swaps and collateralized debt obligations that fueled the housing bubble, and the commodities futures that simultaneously blew oil prices to record highs, both have Goldman's fingerprints all over them. Fairly or not, Goldman has spent much of the post-crisis era struggling in vain to repair its ugly public image as a "Vampire Squid."

The Dow change that inducted Goldman gave the financial sector its heaviest weighting in the index in history, so it's certainly possible to argue that the company is out of place. However, it's much harder to say which company, if any, would be a better representative of the American economy. After all, Goldman is consistently responsible for some of the business world's biggest deals. You may not like it, but in a way, Goldman Sachs represents America's economy more accurately than many of the Dow's 29 other components.

Goldman Sachs by the numbers

GS Chart

GS data by YCharts.

  • Ten-year share price growth: 90.3%
  • Ten-year dividend growth: 120%
  • Total return (with dividends reinvested): 111.9%
  • Average P/E over the past decade: 11.7 
  • Current P/E discount to average P/E: 9%

GS Revenue (TTM) Chart

GS Revenue (TTM) data by YCharts.

  • Annualized revenue growth (past five years): 3.9%
  • Annualized EPS growth (past five years): 24.1%
  • Annualized free cash flow growth (past five years): (29.8%)
  • Change in profit margins (past five years): 62.6%

Goldman Sachs will always be more difficult to assess than most of its Dow peers, simply because so much of what the company does is tied to forces beyond its direct control. Goldman can't guarantee that it will be able to sell more derivatives, guide more companies to market, or negotiate more bond sales, because there's always the possibility that its potential clients will close up their pocketbooks or simply decide to work with another firm.

That doesn't mean that Goldman lacks a strategy -- its wealth of top investment and economic talent produces hundreds of different strategies every year -- but it does mean that projecting Goldman's future success is perhaps more an art than it is a science. The 17 analysts who assessed Goldman's growth prospects differ quite a bit in their range of estimates for the company's fiscal 2014, from a low-end earnings-per-share estimate of $13.67 to a high-end EPS estimate of $18. On average, analysts expect Goldman to grow its EPS by roughly 7.2% per year for the next five years, which is respectable, but perhaps a tad optimistic, since the company's growth has been so erratic, and so dependent on economic conditions, since it went public in 1999.

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Alex Planes holds no financial position in any company mentioned here. Add him on Google+ or follow him on Twitter @TMFBiggles for more insight into markets, history, and technology.

The Motley Fool recommends Bank of America and Goldman Sachs. The Motley Fool owns shares of Bank of America. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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