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Warren Buffett's Investment in Goldman Sachs

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Warren Buffett's Investment in Goldman Sachs Powered By Docstoc
					Warren Buffett, CEO of Berkshire Hathaway, continues to use his firm's enormous
cash reserves to make purchases into some of the most valued, but down trodden,
American companies. Buffett declared another deal this week, the first week of
October, 2008: He's purchasing $5 billion worth of perpetual preferred stock in
Goldman Sachs (NYSE:GS), plus an option to buy at a greatly discounted rate for the
next 5 years.(. Buffett will get a 10% dividend and the stock is callable after three
years at a 10% premium. As arguably the world's greatest living investor, Buffett's
investment moves are always watched by the public and news media. When Buffett
invests in a firm, like Goldman Sachs, it's a very valuable endorsement. This time it's
an endorsement of not only this company but the free market system.

To determine why Buffett found this a good investment, I looked at many criteria as
found in the book Buffettology, written by Buffett's former daughter-in-law, Mary
Buffett and the website validea.com. Given Buffett's new investment in Goldman
Sachs, I thought it would be worthwhile to look in detail at the common stock.

GS earns high marks based on my Buffett strategy, earning a score of 79% out of
100%. Let's look at what the Buffett strategy likes about Goldman Sachs to shed some
insight into one way Buffett may have looked at this investment. First off, Goldman
Sachs is a large global bank holding company that engages in investment banking,
securities and investment management. Goldman Sachs was founded in 1868, and is
headquartered in the Lower Manhattan area of New York City at 85 Broad Street.[1]
Goldman Sachs has offices in most major world financial centers. The firm acts as a
financial advisor and money manager for corporations, governments, and wealthy
families around the world. Goldman offers its clients mergers & acquisitions advice,
underwriting services, asset management, and engages in proprietary trading, and
private equity deals. It is a primary dealer in the U.S. Treasury securities market.

That's the qualitative side of it. Now let's look at the quantitative side, which is where
my Buffett model comes into play. GS has the steady, reliable earnings history that
Buffett likes to see. Buffett likes companies to have solid, stable earnings that are
continually expanding. This allows him to accurately predict future earnings. Annual
earnings per share from earliest to most recent were 5.67, 5.57, 6.00, 4.26, 4.03, 5.87,
8.92, 11.21, 19.69, 24.73. Buffett would consider GS's earnings predictable, although
earnings have declined 3 time(s) in the past seven years, with the most recent decline
6 years ago. The dips have totaled 36.2%. GS's long term historical EPS growth rate is
14.4%, based on the 10 year average EPS growth rate.

Consistent profitability is not enough. In addition, Buffett likes to see a high return on
equity (ROE). Over the past 10 years, GS has an average annual ROE of 19.3%.
That's plenty good for meeting this model's 15% minimum requirement. The ROE for
the last 10 years, from earliest to latest, is 37.7%, 24.3%, 17.5%, 11.1%, 10.0%,
12.8%, 17.1%, 17.5%, 22.7%, 22.6%, and the average ROE over the last 3 years is
20.9%, thus passing this criterion. GS's management has proved it can earn
shareholders 21.4% return on the earnings they kept. This return is more than
acceptable to Buffett. Essentially, management is doing a great job putting the
retained earnings to work.

Share buybacks are also important and GS's total shares outstanding have fallen over
the last five years, although the half-billion share secondary offering on Thursday will
no doubt alter that trend.

So, for the most part, the firm gets high scores on a fundamental basis, but there are
two measures where it falls short. One is the Capital expenditures and another is
return on assets. Both are likely to improve and Buffett has required key management
to hold their shares during the time Buffett remains invested. A

fter the business analysis is done, he then moves onto the question, "Is the price
right?" Consider this: GS's stock is currently at 128, down from a high of 225 a year
ago. We know that Buffett wants to invest when others are most "fearful" and at a
price that gives him a reasonably good chance at making a profit over the long run.

Buffett gets a great deal with these preferred shares, but I think long-term investors
may be presented with a wonderful buying opportunity here in the common shares as
well. While this is a favorable piece on GS, it is more about providing you with
insight into how to evaluate stocks for your own investment success.

				
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