Will Goldman Sachs Rocket Back To Two Times Book Value?

Goldman Sachs trades extremely low compared to its own historical valuation metrics and should do extremely well for investors in a sustained bull market.

Kingkarn Amjaroen
Kingkarn Amjaroen
Jul 17, 2014 at 3:58PM

Source: Company

Goldman Sachs (NYSE:GS)trades at an extremely low book valuation, that doesn't do justice to its own historical valuation.

Historically, the investment bank has seen book value multiples way north of 2x in periods of exuberance and there is no reason why Goldman Sachs wouldn't be able to achieve similar valuations down the road -- especially if the bank can carry forward its second quarter revenue momentum in Investment Banking and Lending.

Goldman Sachs' investors have lots of reasons to be cheerful about the investment bank and its stock.

This is especially true for investors who were lucky enough to snatch up the premier investment bank two years ago as it has delighted investors with a solid share price return of 74% over the last 24 months.

Not a bad return at all and especially noteworthy given the generally unfavorable sentiment of investors toward the financial sector.

But sentiment often changes. It changes slowly, but it usually changes. Not too long ago, Goldman Sachs was trading close to book value -- an extraordinary circumstance for a bank, that was accustomed to be trading at a generous premium to book value.

Goldman Sachs' second quarter results make appetite for more
The investment bank's second quarter results highlighted, that the company is definitely on the right track to achieve a higher valuation. Especially noteworthy has been, that Goldman Sachs' produced solid year-over-year revenue growth whereas most other banks reported revenue declines in the most recent quarter.

For the second quarter in fiscal 2014, Goldman Sachs reported a year-over-year increase in revenues of 6% to $9.1 billion which compares against $8.6 billion in the year ago quarter.

Source: Wikipedia Commons

Diluted earnings per share came in at $4.10 compared to $3.70 a year ago (a plus of 11%). Analysts expected revenues of approximately $8.0 billion and an earnings per share drop to $3.05.

Goldman Sachs' results were largely driven by strong performances in Investment Banking where revenues increased 15% year-over-year, in Investing & Lending which saw a y-o-y top line increase of 46% driven by equities and in Investment Management where revenues grew 8%.

Strong revenue gains in these divisions helped offset 11% lower revenues in Goldman Sachs' Institutional Clients Group which is the largest revenue contributing business unit within Goldman Sachs accounting for 42% of total second quarter group revenues.

Goldman Sachs' results certainly made a case of how difficult it really is for analysts' to accurately forecast group or segment earnings as the inherent cyclicality of Goldman Sachs' business model can cause large forecasting errors.

Lloyd C. Blankfein, Chairman and Chief Executive Officer commented on Goldman Sachs' second quarter results:

We are pleased with our results for the quarter in the context of mixed operating conditions during the period. This performance was driven by the diversity, strength and breadth of our global client franchise.

Is Goldman Sachs expensive?
Bank valuations generally have corrected and normalized for major investment banks over the last couple of years, while commercial banks like Citigroup and Bank of America are still disappointing investors with their mortgage mess which continues to mercilessly haunt the two banks.

Goldman Sachs, however, has circumvented most of problems that commercial banks had to deal with and its valuation has more or less gradually increased over the last two years.

The bank now trades at a slight premium to book value, but the bank isn't necessarily expensive, compared to its historical valuation.

Before the financial crisis, it wasn't unusual for Goldman Sachs to trade at a solid premium of way more than 2x book value -- and this goes for both a tangible and a total book value basis.

With a current multiple of just above 1x (tangible) book value, Goldman Sachs is certainly cheap compared to its historical valuation.

Compared against other investment banks with similarly cyclical earnings profiles -- namely J.P. Morgan and Morgan Stanley -- Goldman Sachs also appears reasonably valued.

The Foolish Bottom Line
Investors who buy want to buy premier investment bank Goldman Sachs should know, that they get a fair deal on a valuation basis, both compared to Goldman Sachs' historical valuation as well as compared to its immediate investment banking peers.

Though Goldman Sachs' earnings are going to be dependent on volatile investment banking activity and trading as well as the overall state of the capital markets, investors who believe in a sustained bull market have a lot of reason to believe, that Goldman Sachs can return to historical valuations of more than 2x book value.