The Goldman Sachs Group Inc (NYSE:GS) Is Trading 8.84% Below Its True Value

Valuing GS, a financial stock, can be daunting since these capital market firms generally have cash flows that are impacted by regulations that are not imposed upon other industries. For example, capital market businesses are required to hold more capital to reduce the risk to shareholders. Focusing on line items such as book values, as well as the return and cost of equity, may be beneficial for evaluating GS’s valuation. Below we’ll take a look at how to value GS in a relatively effective and uncomplicated method.

Check out our latest analysis for Goldman Sachs Group

Why Excess Return Model?

Let’s keep in mind two things – regulation and type of assets. The regulatory environment in United States is fairly rigorous. In addition to this, capital markets tend to not possess large amounts of tangible assets on their books. So the Excess Returns model is suitable for determining the intrinsic value of GS rather than the traditional discounted cash flow model, which places emphasis on factors such as depreciation and capex.

NYSE:GS Intrinsic Value Export August 8th 18
NYSE:GS Intrinsic Value Export August 8th 18

The Calculation

The central belief for Excess Returns is, the value of the company is how much money it can generate from its current level of equity capital, in excess of the cost of that capital. The returns above the cost of equity is known as excess returns:

Excess Return Per Share = (Stable Return On Equity – Cost Of Equity) (Book Value Of Equity Per Share)

= (12.1% – 10.53%) x $216.3 = $3.38

Excess Return Per Share is used to calculate the terminal value of GS, which is how much the business is expected to continue to generate over the upcoming years, in perpetuity. This is a common component of discounted cash flow models:

Terminal Value Per Share = Excess Return Per Share / (Cost of Equity – Expected Growth Rate)

= $3.38 / (10.53% – 2.95%) = $44.59

These factors are combined to calculate the true value of GS’s stock:

Value Per Share = Book Value of Equity Per Share + Terminal Value Per Share

= $216.3 + $44.59 = $260.89

This results in an intrinsic value of $260.89. Relative to the present share price of US$238, GS is , at this time, priced in-line with its intrinsic value. Therefore, there’s a bit of a downside if you were to buy GS today. Pricing is only one aspect when you’re looking at whether to buy or sell GS. There are other important factors to keep in mind when assessing whether GS is the right investment in your portfolio.

Next Steps:

For capital markets, there are three key aspects you should look at:

  1. Financial health: Does it have a healthy balance sheet? Take a look at our free bank analysis with six simple checks on things like leverage and risk.
  2. Future earnings: What does the market think of GS going forward? Our analyst growth expectation chart helps visualize GS’s growth potential over the upcoming years.
  3. Dividends: Most people buy financial stocks for their healthy and stable dividends. Check out whether GS is a dividend Rockstar with our historical and future dividend analysis.

For more details and sources, take a look at our full calculation on GS here.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.