Beat The Bankers By Joining Them

Published in Investing on 29 March 2012

Should you buy shares in an investment bank?

Bankers have had a bad press in the last few years. Many richly deserve it, especially those whose reckless management caused the collapse of Bradford & Bingley, HBOS, Northern Rock and The Royal Bank of Scotland (LSE: RBS), forcing the government to bail out their creditors in order to prevent the financial system from imploding.

But there were some well-run banks that didn't need bailouts, notably HSBC (LSE: HSBA) and Standard Chartered (LSE: STAN), whose shareholders still have something that's worth owning. Investors who want a piece of the banking action might be better off looking at banks like these, rather than those who went cap in hand to the taxpayer.

No bailout for us, but…

One bank which didn't need a bailout, but which still attracts a huge amount of criticism for its role in the credit crunch, is the American investment bank Goldman Sachs (NYSE: GS.US).

Many people are, to put it mildly, seething as they see Goldman Sachs as having exploited its political connections to get billions of dollars from the US taxpayer through the backdoor when it bailed out the insurer American International Group (NYSE: AIG.US).

I believe that investors should approach the world as it is; not how they would like it to be (my one exception is that I won't invest in tobacco companies). So if banks like Goldman Sachs are getting a piece of the taxpayers' money whilst making a profit at the same time, why not grab some for yourself by owning their shares?

Tell the difference

There are basically two types of bank; commercial and investment. Commercial banks are the high street banks, former building societies and other institutions, which operate our current and deposit accounts. They make loans to individuals and companies, and some also have other interests, such as in-house insurance and fund management businesses.

Investment banks raise capital for companies and governments, make markets for share and bond trading, deal in investments on their own account, and advise companies on things like mergers and takeovers. They don't tend to deal with private investors, unless they are very rich, though some run funds in which members of the public can invest.

Bad publicity

There is such a thing as bad publicity, and Goldman Sachs has had plenty of it in the last few years. Top of the pops is the much-referenced article published by Rolling Stone magazine in 2010 which called it "a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money."

Forbes has questioned whether it is "The Death Star of Capitalism", and two weeks ago the negative publicity machine got another boost when the New York Times published an employee's resignation statement, which said that Goldman Sachs had acquired a toxic and destructive culture that exploited its clients.

Goldman Sachs has shrugged off this criticism, and plenty more, and unlike most banks it still makes money both for its very well-paid staff and shareholders.

Show me the money

Goldman Sachs was founded in 1869, but it only became a public company in 1999, when its shares were listed at $53. They have outperformed most banks and the S&P500 index since then, and as I type this they trade at $126.33.

Earnings per share (eps) for 2011 were $4.51, a fall of 66% when compared to 2010, when it earned $13.18 a share. The quarterly dividend is 35 cents, so after 15% American withholding tax this represents a net yield of just over 0.9% to British taxpayers.

Whilst the historic price-earnings (P/E) ratio is a very high 28, the current consensus eps forecast for 2012 of $11.43 puts them on a far more modest prospective P/E ratio of just over 11.

Volatile earnings and bonuses

Investment banks' earnings are very dependent upon the profits made by their proprietary trading departments. Their mergers and acquisitions work generally falls when the economy is performing poorly, so their shares are often lowly rated by the market.

Whilst Goldman Sachs gets a lot of attention because its employees are extremely well-paid, particularly if it is bonus time at the end of a good year, it gets its pound of flesh out of them with hundred-hour working weeks being the norm.

So, if you're looking for a bank which is a well-oiled money-making machine, you could do a lot worse than to get a ride on Goldman Sachs' coattails by becoming a shareholder. After all, any company which sacks the bottom 10% of its staff every year has found an excellent, if ruthless, way to motivate those who want to stay on board the gravy train.

I should point out that Goldman Sachs can't be as bad as many people think, as Warren Buffett of Berkshire Hathaway (NYSE: BRK-B.US) fame is a big fan of the company.

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> Tony owns shares in Berkshire Hathaway. He's thinking about buying some Goldman Sachs shares, but first of all wants to perfect his Dr. Evil impression (which may take some time). And he doesn't own a white cat.

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The opinions expressed here are those of the individual writers and are not representative of The Motley Fool. If you spot any comments that are unsuitable hit the flag to alert our moderators.

CodeGimp 29 Mar 2012 , 11:04am

Springtime for Goldman?
"Don't be stupid, be a smarty - come and join the GS party!"

jf2007 29 Mar 2012 , 1:22pm

"I should point out that Goldman Sachs can't be as bad as many people think, as Warren Buffett of Berkshire Hathaway (NYSE: BRK-B.US) fame is a big fan of the company"

When you say bad do you mean as an investment or are you talking morally as if Buffett is some sort of Gandhi or dalai lama figure

TonyTwoTimes 29 Mar 2012 , 2:18pm

Hi jf2007,

I was talking in terms of morality and standards of behaviour, since that Buffett has pretty high standards himself.



GnomeYOB 29 Mar 2012 , 3:10pm

The senior management of the banks are expert at paying just enough to satisfy shareholders and keeping the rest back for staff bonuses. If you want to make money out of banking work for a bank, don't invest in one.

Tortile 30 Mar 2012 , 7:34am

Well, you should have a portfolio or spread of investments in various companies, at least seven. If you have too many, you may not be able to keep a good track of them. The minimum of seven is so you don't suffer unduly if a single company you invest in goes bust or the shares fall very steeply. Thus, a maximum could be between 15 and 35. If you have £45,000 to invest, you might consider investing in 14 share holdings of £3,000 each. If you have £300,000, you might consider 30 of £10,000.

Avalaugh 30 Mar 2012 , 7:34am

How to make good money from a bank - work for one!
Don't invest since shareholder return isn't the first thought of an organisation that pays out large bonuses,

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