Goldman Sachs Floats On Buffett Moat

NEW YORK ( TheStreet) -- As Warren Buffett prepares to make a "significant" investment in Goldman Sachs ( GS) shares, the nation's top standalone investment bank is just beginning to prove itself as an investment worthy of the pedigree of Berkshire Hathaway ( BRK.A).

For the seventh quarter out of nine, Goldman Sachs ( GS) beat earnings estimates on continued trading and underwriting market share gains. Meanwhile, banking conglomerates and international players have retrenched from Wall Street.

More importantly, as Goldman's near 10% first quarter earnings growth generally reflects a recovery in merger activity, debt underwriting and a thawing of the market for initial public offerings, the firm has laid out a predictable path towards growing its bottom line.

In its first quarter earnings report, Goldman Sachs said it repurchased $1.52 billion in shares during the quarter and received an authorization from its Board of Directors to buy back an additional 75 million shares.

Overall, Goldman Sachs can now repurchase 86.4 million shares, or roughly 18.5% of the firm's outstanding shares. In 2012, the authorization was for a buyback of 46 million shares.

Goldman said in March it would delay capital returns until at least mid-year after the firm passed the Federal Reserve's annual stress tests with mixed results.

The investment bank's shareholders are also getting a larger piece of the firm's recovering post-crisis earnings as a result of declining compensation expenses and overall expense ratios.

Compensation expense fell sharply in the fourth quarter below 40% of revenue. During the first quarter, Goldman's expense ratio declined 1% from year-ago levels to 43%.

All told, the bank is beginning to look like one of the protected and disciplined businesses Buffett likes to invest in.

When taking a near $11 billion stake in IBM ( IBM) in 2011, Buffett made it a priority to explain to his shareholders why he was investing in companies with predictable growth prospects and prospects for expense reductions, including. IBM's EPS growth prospect were supported by a planned $50 billion share repurchase program.

Unlike most banking conglomerates and Wall Street players, Goldman Sachs increasingly fits within the IBM-like criteria that Buffett outlined in his 2011 shareholder letter.

The investment bank is growing its earnings-per-share through net share repurchases and top line growth that makes its financial metrics comparable to other large Berkshire holdings, including IBM ( IBM), American Express ( AXP), Coca-Cola ( KO) and to a lesser extent, Wells Fargo ( WFC).

In contrast to Wall Street peers such as Morgan Stanley ( MS), Goldman is on a trajectory to report EPS figures near pre-crisis highs, even as new regulations and tepid economic growth cast a pall on overall revenue.

A Jan. 14 analysis by Keefe, Bruyette & Woods shows that among large banks submitting capital plans to the Fed, there are just five that have been able to consistently reduce their share count through repurchases in the wake of the crisis, including Goldman, American Express, U.S. Bancorp ( USB), Wells Fargo ( BK) and State Street ( STT).

"Looking forward, capital management will be critical in a slow-growth, highly regulated, banking world, in our view, and the most successful banks will need to be reducing shares outstanding to achieve strong EPS growth," KBW analyst Fred Cannon wrote.

Among primary Wall Street competitors Morgan Stanley, Bank of America, Citigroup and JPMorgan, only Goldman Sachs is a net buyer of shares.

It is no surprise then that Buffett now says he will use a cheaply priced crisis-time warrant contract to take a large position in Goldman Sachs shares.

Buffett's warrant amounts to about 2% of Goldman's shares at current prices and his March statement of a "significant" investment indicates a growing long-term position. Such is currently the case with Wells Fargo, now Berkshire's largest investment.

Still, until Buffett takes his stake in mid-October according to an agreement reached between Berkshire Hathaway and Goldman Sachs, the "Oracle of Omaha" may prove to be an overhang for Goldman's shares, given the prospect of near-term dilution.

On Tuesday, the bank reported better than expected earnings of $2.26 billion, on revenue of $10.09 billion, beating adjusted estimates of $1.97 billion and $9.65 billion respectively.

Earnings of the nation's top standalone investment bank reflected record quarterly debt underwriting revenue of $694 million.

Goldman's investment banking unit and debt trading business posted particularly strong results, while equity trading revenue of $1.92 billion came in lower than some analyst estimates.

Goldman Sachs shares fell over 1.5% to $143.93 in early Monday trading.

For more on Goldman Sachs see why the company's bottom line will be its key earnings driver in 2013.

See what Warren Buffett's Goldman Sachs stake means for Wall Street.

-- Written by Antoine Gara in New York

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