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Is Goldman Sachs a Buy?

By Matthew Frankel, CFP® - Dec 8, 2018 at 8:21AM

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The investment banking giant is now at its lowest valuation in more than two years.

Thanks to a lingering legal issue and general weakness in the financial sector, investment banking giant Goldman Sachs (GS -0.95%) is trading for less than its book value for the first time since early 2016. While legal uncertainty can certainly be scary, at some point institutions like Goldman Sachs simply become too cheap to ignore.

With that in mind, here's a look at the headwinds that have sent Goldman Sachs' stock tumbling in recent weeks, and why the bank could be worth a look for long-term investors despite the near-term uncertainty.

Two businessmen looking at financial data on computer screens.

Image source: Getty Images.

Short-term headwinds have pushed the stock price down

There are a few negative catalysts that have pushed Goldman Sachs' stock price to a fresh 52-week low: poor financial sector conditions, disappointing trading revenue, and legal uncertainty. Let's take these one at a time.

First, the financial sector as a whole. While this is a great environment for banks to grow their profits, much of the good news was already priced in at the beginning of the year. For example, tax reform alone sent many banks' earnings higher by 30% or more, but this was widely expected upon the passage of the Tax Cuts and Jobs Act. The same can be said for rising interest rates -- rate hikes generally translate into higher bank profit margins, but again, the Fed's projection of several 2018 and 2019 interest hikes has been well-known for some time, and if anything, expectations have cooled off recently.

In addition, investors are concerned about the yield curve starting to invert, which not only is a pretty reliable recession predictor but is bad news for bank profitability. Because of all these reasons, the S&P 500 has increased by 1% in 2018, but the financial sector is down by 7%.

Specific to Goldman, trading revenue has been a weak spot industrywide for some time. After all, volatility has been rather low in recent years, which is good for many other aspects of investment banking but is bad for trading revenue. Not only has Goldman's trading revenue been weak, but it's been even weaker than the already-modest expectations in recent quarters.

Most recently, it was announced that Malaysia is seeking to recoup $600 million in fees it paid to Goldman in connection with a failed bond fund. The bank also faces significant legal risk from regulatory agencies in relation to this, in addition to the amount Malaysia is seeking. Uncertainty is bad for stock prices, especially when it could potentially come with a 10-figure price tag.

Extremely cheap valuation

The catalysts above have sent Goldman Sachs stock plunging to a fresh 52-week low. In fact, the bank trades for roughly 9% less than its book value, the lowest price-to-book valuation in more than two years.

GS Price to Book Value Chart

GS Price to Book Value data by YCharts.

A great institution with lots of potential to grow

To be clear, Goldman Sachs stock is certainly down for a reason. The inverting yield curve is definitely a concern, and trading is the bread-and-butter of the company's business, so it's certainly disappointing that trading revenue isn't meeting expectations. Furthermore, the legal uncertainty related to the Malaysia situation could potentially result in a massive hit to earnings if the bank ends up paying back those fees.

Having said that, all of these are temporary concerns. Goldman is still one of the premier investment banks on Wall Street, and still holds the top market share in key areas like equity IPOs and M&A advisory. Additionally, the company's young consumer banking business is growing at a breathtaking pace and has tons of untapped potential to leverage the bank's brand and resources.

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