Goldman Sachs May Grow by Shrinking: Street Whispers

At a price to earnings ratio of 18, Goldman Sachs currently trades at the highest multiple of its peers. Meanwhile, the bank trades at a discount to its $130 in book value per share, in contrast to the more than two-times premium it traded for before the bust, signaling that investors aren't comfortable with balance sheet driven valuations.

Goldman's authorization to buy back up to 46 million shares in coming years is the most aggressive among its investment banking peers after Morgan Stanley (MS), Citigroup (C) and Bank of America (BAC) didn't submit buyback plans during Fed stress tests and JPMorgan (JPM) halted a $15 billion multi-year buyback in August after it incurred what stands as a $5.8 billion trading loss.

Since hitting a high of nearly 550 million in shares after taking a $10 billion in Troubled Asset Relief Program funds and $5 billion in emergency capital from Warren Buffett and private investors, Goldman has reduced already reduced its share count by roughly 12% through repurchases.

In line with Goldman's authorization, International Strategy & Investment Group analyst Ed Najarian calculated in August Goldman may yet cut its share count by 11% and putting shares at roughly 434 million. Were Goldman's earnings to stabilize at say $10 billion, slightly above a three-year post crisis average of $8.71 billion, the bank's EPS would come in at above $23, or the average of its 2006 and 2007 results.

Still the risk for Goldman is that ROE remains at the forefront of investor's minds, with the prospect that chief financial officer David Viniar has to continue apologizing for sub-10% returns. In his August note, ISI's Najarian wrote that Goldman is unlikely to earn a ROE over above 10% in coming years, thus warranting a discounted valuation to its book value.

Meanwhile, a September 7 upgrade to Goldman's share price target to $125 by Jeffrey Harte, a principal with Sandler O'Neill hinges on confidence that the bank can post 20%-plus ROE's, without mentioning a forecasted 78% rise in 2013 EPS or the impact of share buybacks.

As investors parse over investment banking names, they may be well served to focus on banks like Goldman with the share repurchase and earnings dynamics that may yield earnings per share growth in coming quarters and years, even if the sector remains constrained by a deleveraging environment that cuts at revenue opportunities and balance sheets.

--Written by Antoine Gara in New York

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