The news that Goldman Sachs, one of the last and certainly the most prestigious private partnership on Wall Street, has filed to sell a roughly 12% stake in itself to the public inspires some thoughts on the super-bull market. Upon any fair reading of the evidence, this market may be said by now to be in its 17th year of rising stock prices and expanding multiples.
These thoughts occur because Goldman, more so than perhaps any other firm in business today, has profited both financially and in terms of image from this nearly two-decades-long explosion in securities values. The company is now seeking to capitalize on those benefits through an offering that puts a potential $28 billion market value on the business -- a business that, using the valuations of the offering document, would have been worth less than $4.2 billion as recently as five years ago.
Surprisingly, $24 billion to $28 billion actually turns out to be a reasonable valuation for the business. But before you hand over your money, you should be aware of something important. As with other Wall Street firms, Goldman is in a business whose future and fate is simply not in its own hands. In reality, an investment in Goldman Sachs actually turns out to be an investment in
, the evidence for which we'll explore in a minute.
Goldman has been and continues to be an unusually successful investment firm. It has survived longer as a partnership than any other major Wall Street firm of the post-World War II era and has regularly (though not always) done better than its rivals in leveraging the firm's equity capital into higher returns for the owners. Since 1994, the firm has raised nearly $1 trillion in capital for its clients around the world, has managed nearly $2 trillion worth of mergers and acquisitions and has underwritten more than $44 billion in initial public offerings. Those are big numbers in anybody's book.
But the thing that Goldman has been best at, the thing that puts it in a class apart from every other firm on Wall Street, has been its obsessive (and successful) cultivation of its image. As burnished by the company and its press minders, that image has come to portray the firm's partners and employees as the very quintessence of white-shoe professionalism and decorum on Wall Street: the kind of investment bankers who are aggressive yet fair and always law-abiding and respectful of their elders -- what used to be known in an earlier time as a "class act" kind of business.
And, frankly, I personally have no reason to doubt any of it. But, well, when it comes to Goldman -- and
Morgan Stanley Dean Witter
and all the others -- the image thing is pretty much beside the point. The truth is, even if the whole of Wall Street were populated by three-toed sloths and recreational substance abusers, the investment business would still be selling for six times its value of five years ago.
In that regard, here is a fact to think about -- a fact that, ironically enough, is immortalized right there on page 8 of Goldman's endlessly detailed 523-page IPO offering statement. It appears in a section titled "Key Industry Indicators," and it is offered, we may assume, to bolster the case as to why you should buy Goldman's shares.
The section reports that during the 15 years from 1983 to 1998, worldwide economic output barely tripled to $29 trillion. Yet during the same period, the market value of equity stocks worldwide soared sevenfold, to an incredible $23 trillion, while the amount of new borrowings worldwide rocketed 20-fold to nearly $3 trillion.
This has happened basically because for the past 15 years, the Federal Reserve has been printing money at almost twice the rate of growth in the economy. And since 1995, that growth rate in the money supply has exploded from a 6% annual rate to an 11% rate, which is the fastest sustained growth rate for money since the Fed was trying to reinflate the economy out of the recession at the start of the 1980s.
Adjust those numbers for annual economic output, and if you go back over the past 40 years, you will not find a single nonrecessionary period when the Fed was cranking out more money over and above the demands of the economy than it has been doing since 1996.
That excess liquidity -- and nothing else -- has been fueling the superboom in the stock market. It is why the
industrials have nearly doubled since the start of 1996, and why an entire generation of new investors is now convinced that Internet junk stocks like
are actually worth something. And most especially for our purposes here, it is why the partners at Goldman now hope to sell 12% of their business in a $3.4 billion IPO, when
Sumitomo Bank of Japan
bought almost exactly the same amount in a privately arranged deal in 1986 for only $500 million.
So what is Goldman really worth? In fact, the IPO valuation doesn't seem to be far off, though coming as it is at the top of the market, one may certainly wonder whether this deal is nothing more than a replay of Goldman Sachs Trading Corp., the hot stock on Wall Street exactly 70 years ago that tanked in the October 1929 crash and blackened the firm's reputation for a generation.
Up until last autumn, Goldman's major rivals -- Morgan Stanley, Merrill and Lehman -- were selling for a mere nine times year-ahead earnings, dragged down by fears that the mess in hedge funds (or was it Brazil?) would trigger a credit crunch that would cause the stock market to collapse. At that point, Greenspan began frantically stuffing money into the system as if he were ramming corn down the gullet of a goose. In the past 40 years, there have been only 18 months when the money supply grew faster than it did last November, and 17 of them fell during the 1970-1982 era of economic horrors.
The Fed's action predictably caused the Dow industrials to spurt 30% in value in the past six months -- and the value of Morgan Stanley, Merrill and Lehman each to more than double at the same time. So let's say that the current price levels for these companies are an aberration, and that more or less midway between last autumn and now is roughly where they belong -- in other words, at somewhere around 13 times year-ahead earnings.
Now, based on the numbers supplied in Goldman's offering statement, it is impossible to make much more than a good old Eye to the Keyhole guesstimate as to what the firm's year-ahead earnings are likely to be. For one thing, roughly a third of the firm's net revenue derives from what the offering document refers to as "Trading and Principal Investments." Mainly, this boils down to things like gambling as a market maker on Nasdaq stocks, speculating in derivatives and currencies and placing bets on M&A deals.
You can make a lot of money in those pursuits if you're lucky, but you can also lose a lot, which is why the man who ramped up the trading operation in the first place, co-Chairman Jon Corzine, will be leaving the firm once the IPO goes to market. He's been replaced already by Henry M. Paulson Jr., who comes from the firm's investment banking side, which also contributes about a third of the company's net revenue and where the business is more stable. The remaining third of the business comes from managing money for rich folks and that sort of thing.
Nonetheless, the trading operation casts a continuing uncertainty over the earnings outlook for the rest of the firm; you just never know when something is going to blow up in Brazil, Russia or someplace like that, and an avalanche of losses will descend on the firm. In the fourth quarter of 1998, the firm lost $663 million on just such trading activities, reducing pretax income for the entire firm by more than 18% to $2.921 billion for 1998.
So let's take the company's average annual 13% growth rate in earnings over the past 15 years, add it to the company's 1998 net income of $2.428 billion, then multiply the investment banking and asset management components (roughly two-thirds of the business) by our year-ahead price-to-earnings multiple of 13 for the sector (result: $23.540 billion). Then let's throw in the value of the trading segment at no more than the face value of its imputed earnings ($800 million) because the basic business is a crapshoot. (Why pay more than your winnings when all you're really doing is rolling the dice, anyway?)
On this admittedly rough-and-ready basis, we come up with exactly what Goldman is seeking in its IPO: a $24 billion valuation, give or take, for its business, rising to $28 billion if the deal is a smash and Goldman, which is actually underwriting the deal, winds up exercising its overallotment.
So go ahead, take a flier on this white-shoe offering. Who knows? It might even prove a hot deal with some juicy aftermarket upside -- especially if momentum traders jump aboard. On the other hand, remember that at 50 a share, you are not investing in a company filled with financial geniuses. You're betting that the inflation of financial assets has become a permanent feature of life on the planet and that no matter how high the price level climbs, Greenspan and his gang at the Fed will not let it return to earth.
Christopher Byron's column appears in the New York Observer, and he also writes a Wall Street and investing column for Playboy. He is the former assistant managing editor for Forbes, the Wall Street correspondent for Time and the Bottom Line columnist for New York. Byron holds no positions in any of the stocks discussed in his column. While he cannot provide investment advice or recommendations, he welcomes your feedback at