Kass: Goldman Rules, but Don't Buy the Stock

It's Wall Street's darling, but market trends are moving against it.
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This column was originally published on Street Insight on June 14 at 8:09 a.m. EDT. It's being republished as a bonus for TheStreet.com and RealMoney.com readers.

Twenty years ago, every mother wanted her child to grow up and become a doctor. Today, every mother wants her child to grow up and become a

Goldman Sachs

(GS) - Get Report


And there are some very good reasons for this.

Goldman Sachs is one of the world's leaders in mergers and acquisitions, private equity, trading and syndicate. Its market capitalization is approaching $100 billion, and its return on equity is a staggering 31%. The investment bank is justifiably recognized as a gateway to riches for its employees and partners.

Goldman's client base is broad and of superior quality. And as a measure of how well-regarded the company's principals are, many of its retiring partners (Rubin, Whitehead, Paulson, etc.) become prominent members of the government and industry.

This morning, Goldman Sachs reported its quarterly profit and, as in the last few reporting periods, it beat expectations, this time by 2.9%. (The company had beaten analysts' quarterly estimates by, on average, 16.2% over each of the last previous four quarters, ranging from +9.1% to +34.2%.)

I would not own Goldman Sachs, although I not would short it either -- in all likelihood, its gravy train will continue. However, I do have some reservations, which suggest that the risks in owning GS' shares are increasing -- and may not be balanced with the rewards.

  • Although Goldman Sachs' employees/partners are the best in their craft, they are not immune to market trends. Indeed, Goldman's VAR -- its value at risk, which is a measure of how the market value of an asset or of a portfolio of assets is likely to decrease over a certain time period under usual conditions -- has been moving steadily higher while the volatility of the markets it serves has moved steadily lower. Should volatility, credit spreads and trading activity regress back to mean levels, even the gifted Goldman personnel will be affected, and their profits will chill.
  • As a leader in mergers and acquisitions, Goldman Sachs is the mortician(it takes companies private and out of the public market) and the obstetrician (it takes the same -- and other -- companies public. As such, any downturn in M&A or private-equity activity (and there are emerging signs of a peak) will have a negative and leveraged impact on the investment bank.
  • While statistically cheap (along with the rest of the sector), institutional ownership of Goldman Sachs has never been higher. As recently as the late 1990s, that was not the case. This means that Goldman's attributes and market position are not undiscovered. Loved by those who invest/trade at the altar of momentum, the shares have risen by 65% over the last 12 months.
  • Although it cannot be calculated precisely, Goldman Sachs' exposure to the hedge-fund industry is broad in both the trading and prime brokerage sides. That exposure helps to explain some of Goldman's successes over the last decade. However, any dislocations -- a market collapse, derivative problems, etc. -- would pose profit problems for the company.

At time of publication, Kass and/or his funds had no positions in stocks mentioned, although holdings can change at any time.

Doug Kass is founder and president of Seabreeze Partners Management, Inc., and the general partner and investment manager of Seabreeze Partners Short LP and Seabreeze Partners Short Offshore Fund, Ltd. Until 1996, he was senior portfolio manager at Omega Advisors, a $4 billion investment partnership. Before that he was executive senior vice president and director of institutional equities of First Albany Corporation and JW Charles/CSG. He also was a General Partner of Glickenhaus & Co., and held various positions with Putnam Management and Kidder, Peabody. Kass received his bachelor's from Alfred University, and received a master's of business administration in finance from the University of Pennsylvania's Wharton School in 1972. He co-authored "Citibank: The Ralph Nader Report" with Nader and the Center for the Study of Responsive Law and currently serves as a guest host on CNBC's "Squawk Box."

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