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The very worst of the summer credit panic may have passed, but Wall Street banks are still firmly on probation. Lehman Brothers, Merrill Lynch and Bear Stearns have all seen their share prices slashed by 20-30 per cent this year, as investors fret about further writedowns and the potential for reduced earnings power as key businesses such as mortgages remain battered into next year. Morgan Stanley’s shares are down 3 per cent.
So what happened to Goldman Sachs? Its shares hit an all-time high this week. They are up by almost 50 per cent since the darkest days of mid-August and 20 per cent this year, valuing the bank at nearly $100bn. Investors have convinced themselves that Goldman really is different.
On some levels they are right. Goldman is enviably diversified across products and geographies. It has a long record of investing heavily in the booming area of alternative asset management. Most importantly, investors have started to believe that Goldman is simply a better trader and risk manager than its peers. The third quarter was a defining moment. In spite of credit market turmoil, Goldman’s net profit rose 80 per cent year on year (admittedly, fuelled by a big one-off private equity gain). Lehman, the next best, saw profits fall 3 per cent. Some other banks lost their shirts.
In addition, Goldman’s return on equity has dwarfed that of its peers for the past few years. Investors are increasingly confident that Goldman’s “black box” will continue to spit out great results.
The firm deserves a premium rating. But it does not walk on water. During the tough years 2001 to 2003, Goldman’s return on equity actually lagged behind its peer group. It made trading mistakes in 2005 and will do so again.
The valuation gap that has opened with its rivals simply looks too big. Goldman trades on 2.9 times book value, according to Merrill Lynch, versus 2.1 times for Morgan Stanley and 1.6 times for Lehman. The Goldman bandwagon could roll for a while. But, in the medium term, it would be wise to bet that the gap will narrow.
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