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Goldman's Fortuitous Dow Upgrade

NEW YORK ( TheStreet) -- The last thing Goldman Sachs (GS - Get Report) and its long-term investors likely want is a sudden surge in the firm's share price in the final two weeks of the third quarter. Thankfully, Goldman's inclusion in the Dow Jones Industrial Average on Tuesday and an over 3% share price pop comes at a perfect time for the firm and its investors.

Goldman Sachs faces a dilemma heading into the final quarter of 2013.

The firm is poised to enter the Dow Index on Sept. 20, and on Oct. 1 it will take on Warren Buffett-run Berkshire Hathaway (BRK.A - Get Report) as a significant investor. While both developments may signal Goldman's resilience five years after the financial crisis put the firm on the doorstep of collapse, they also may be a marginal risk in the short-term for shareholders.

When Warren Buffett invested $5 billion in Goldman Sachs preferred shares in 2008, the "Oracle of Omaha" also received five-year warrants to buy about 43.5 million of the firm's shares at a strike price of $115. Earlier in 2013, Buffett and Goldman reached a deal where Berkshire would convert its profits on those warrant contracts into actual shares.

The conversion will give Berkshire an equal value in shares to the difference between the price of Goldman's stock in the 10 trading days preceding Oct. 1, and the exercise price of the warrants. The size of Berkshire's stake will depend on how high or low shares trade during those 10 days.

At current prices, Berkshire is poised for about a $2.2 billion stock holding in the investment bank that would represent roughly 3% of its outstanding shares.

Thankfully, Goldman's 3% Tuesday share price rise on a technical matter like the firm's inclusion to the Dow Index won't be included as one of the trading days that governs the size of Berkshire's warrant conversion. September 20, the day Goldman will actually join the Dow, will be one of the trading days included in the conversion.

All of this is marginal for Berkshire Hathaway. The company after all is poised to become one of Goldman's largest shareholders at no cost. For other Goldman Sachs shareholders, Buffett's stake could be a bigger issue.

During the first six-months of 2013, Goldman repurchased 20.6 million shares worth a total of $3.12 billion, the company said in its second quarter filing with the Securities and Exchange Commission. But Goldman has yet to fully unveil the scope of its planed repurchase activity after the Federal Reserve asked for more information about the firm's capital planning in March.

One question mark hanging over investors is whether the firm's annual stock-based compensation and the Berkshire's warrant conversion and will dilute the firm's earnings per share.

For now, Goldman's rising profile given its inclusion into the Dow isn't hitting investors' pocketbooks. It is not so clear that would be the case had S&P made its announcement a week from now.

A $5 share price rise on Tuesday, were it to have been counted in Berkshire's conversion window and held through those 10-trading days, would cost Goldman about $220 million.

All signs indicate that even after Berkshire converts its warrants for a share stake in excess of $2 billion, Goldman will continue to reduce its share count heading into year-end, a contrast to most of its banking industry competitors.

Ultimately, the inclusion of Goldman Sachs into the Dow combined with Berkshire's imminent investment are positive developments, as the bank it tries to inspire confidence in its brand five years after the crisis.

For now, Goldman can count itself lucky that its rising public relations fortunes aren't hitting the bank's bottom line. Goldman Sachs shares were up over 3% to $164.88 in late morning trading on Tuesday.

-- Written by Antoine Gara in New York

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