How Much Is Goldman Sachs Really Worth?

Over the past week or so, I've seen multiple articles questioning how Goldman Sachs (NYSE:GS) is being valued. Specifically, questions have been raised over why Goldman, which has been accused in the past of being a big hedge fund itself, is valued at less than 10 times trailing earnings when public-markets newcomer Fortress Investment Group (NYSE:FIG) is trading at a 40-plus multiple. As the Financial Times pointed out, Goldman manages $147 billion of alternative assets versus $30 billion for Fortress and $79 billion for Blackstone -- which will likely get an impressive valuation if its IPO makes it to market.

So just how should we look at Goldman?

Investment banking
The easiest part of its business to consider is probably the investment banking arm. This is in part because banking is one of the more transparent businesses for the very opaque firm, but also because there are a bunch of reasonable comparables in the public markets. I considered the following:

Some of these firms have other businesses besides advisory-based services, but the majority of their revenues are from investment banking and advisory, so it should be safe to use these multiples. Just to be conservative, I took a nice round multiple of 20 for Goldman, just less than the average of the group. This gives Goldman's banking arm an equity value of about $20 billion -- assuming a 35% tax rate on its 2006 pretax income.

Asset management
The asset management arm of Goldman is what everyone has been looking at as Fortress prospers on the public markets and Blackstone and others eye up potential offerings. How to value a business like this is an interesting question, though. The fees for alternative asset managers are lower than those of the more traditional asset managers, but there is serious upside for the alternative crew through the performance-based fees.

Unfortunately, there aren't too many great options in terms of publicly traded comparables for alternative asset managers. I considered the following:

The first two firms listed are the closest comparables. We've already discussed Fortress briefly; it manages $30 billion, most of which is in private equity funds, with the bulk of the remainder in hedge funds. Man Group has about double the AUM of Fortress and has a number of different alternative funds. Man also has a brokerage arm, though the majority of its business comes from asset management. The remainder of the firms listed here should be pretty recognizable as traditional asset managers.

Again going the conservative route and using 25 as a multiple for Goldman's asset management business, I come up with a $40 billion value for this part of the firm (again assuming a 35% tax rate on its 2006 pretax income).

Trading and principal investments
We have so far accounted for $60 billion in equity value for Goldman through the first two business segments. And now we come to the largest, most profitable, and fastest-growing piece of the firm's business.

The reason I have left this segment until the end is because it is probably the most opaque part of the firm, and the one that gives the investors the most pause. Investors typically like businesses that are transparent and can be relatively easily forecast, and that is not how you'd describe this business unit.

According to Goldman's 10-K, the trading and principal investments segment consisted of, among other things: commodities and commodity derivatives (including power generation activities), credit products and derivatives, currencies and currency derivatives, interest rate products and derivatives, asset-backed instruments, insurance activities, equity securities and derivatives, specialist and market-making activities, and principal investments in connection with merchant banking activities.

OK, still with me? To complicate things, these activities are done both on behalf of clients and in proprietary trading activities. Forecasting this business must give Goldman CFO Dave Viniar nightmares!

Taking the $60 billion we have so far from the other two businesses and backing that out of the $84 billion that Goldman is currently fetching on the public market, I come up with $24 billion for its trading and principal investments segment. That would imply a multiple of less than four for this segment.

Tweaking the levers
If you take this at face value, it may seem like investors are getting that final business segment for a real steal. And this could well be the case. Worth considering, though, is the fact that investment banking pretax income more than tripled in 2006. This kind of growth is not likely to be repeatable and could even be pared back.

Investment banking and advisory has also been a great business lately because of the strength of the markets and the amount of buyout activity. A decline in market conditions could also hurt the banking segment. Both of these issues could affect what investors are willing to pay for Goldman's banking division.

On the asset management side, Goldman has been struggling a bit. In particular, its flagship hedge fund, Global Alpha, has been on the wrong side of some of its bets, and its performance has been lagging. This may mean that it would fetch a lower multiple than what I've assumed.

The Foolish bottom line
This has been a pretty basic look at Goldman's valuation. It doesn't take into consideration some important issues, such as how highly leveraged the firm is -- an issue that introduces a healthy amount of risk. It does, however, give a view of how investors could look at the individual business segments in light of how comparable businesses are being valued.

Rounding out this exercise, I would suggest that it may be interesting to value the trading and principal investments segment at a multiple of seven to eight -- similar to the valuation of some of the major oil and commodities players, which are booming thanks to high commodity prices. Using this multiple would suggest that Goldman, despite its 28% gain in the last year, is still trading at a price that gives investors a 20%-plus margin of error.

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Fool contributor Matt Koppenheffer own shares of Goldman Sachs, but does not own shares of any of the other companies mentioned. You can check out Matt's CAPS portfolio here, or tune in to his CAPS blog here. The Fool's disclosure policy knows that diversity is not, in fact, an old, old wooden ship from the Civil War era.