Goldman Sachs – Breaking out of the Blue!

On Friday, February 3, 2012, Goldman Sachs (GS) traded above EBV-3.   This is a big positive, not only for the company but also for the market as a whole.  What does this mean?  The market is recognizing the stated assets on Goldman’s balance sheet is accruing value.  That asset prices, stated loans, and whatever assets Goldman has on its $950 billion dollar balance sheet is going up.

As one can see from the chart below, the market tried this once before in October.  After touching EBV-3, Goldman traded down to the low 90’s, probably on the euro and whatever fears the market had at that time.

Goldman Sachs with weekly price bars, EBV Lines (colored lines) and model price (dashed line)

 

For those interested, a daily updated chart of GS subsequent to this post will be maintained on Facebook, here.  Also please note the volatility in the stock price.  In May, June and July, GS was holding EBV-2.  Very low volatility, and hugging this structural line.  Remember these lines are calculated from the balance sheet independent of the market action.  Once GS broke EBV-3 in September, note the volatility in the action.  Recently, GS has returned to EBV-3 with volatility decreasing as expected.

Why should you care?

A trader/investor should always keep an eye on transits up through EBV-3.  We call this “Coming out of the blue”.  Why?  Subsequent to an upward transit of EBV-3, stocks tend to have powerful moves, price wise, that can take a stock from EBV-3 to at least EBV, or EBV+2.  Sometimes investors, if patient, can ride their winners all the way to EBV+5.

We look for “break out/pull backs”, for higher probability trades.  This occurs when a stock transits above EBV-3, then pulls back under, then breaks above again over a period of weeks/months.  To us this means the market is undecided in terms of the price action which zone the stock belongs.  When the market does decide to stay above EBV-3, could be along side of news and/or corporate action, the price action is very positive.

Obviously, if the stock transits down through EBV-3, all bets are off!

We have been in a bear market for 5 years.  The financials led us in; the financials need to lead us out.  There are clues this bear market has run its course, Goldman represents a big piece of the puzzle.

Other financials have also transited this week Capital One (COF) and SLM Corp. (SLM).  On deck is JP Morgan Chase (JPM).  Long way to go Citigroup (C) and Bank of America (BAC).

As a review, here are 5 reasons why stocks may fall below EBV-3.  Which we call “following into the blue”.

Five things investors’ should know when a stock falls below EBV-3.

  1. If the company is an operating business with a big amount of goodwill on the balance sheet. (Goodwill recorded usually after one or more acquisitions performed by the company).  The market is telling the investor that the “good” goodwill on the company’s balance sheet has turned to “bad” goodwill.  Usually this “bad’ goodwill will be written off in a subsequent quarter or year-end.
  2. If the company in question is a financial, the recorded assets are NOT worth what is stated on the balance sheet.  Market value is worth less than book value.  If the financial is big, say a money center bank, write offs usually do not occur.
  3. Once the company’s stock price falls below EBV-3, the company’s stock price becomes more volatile.  WHY?  The company’s stock no longer has the structure of the EBV lines.  EBV-3 is our last line.
  4. If the company has little or no goodwill, the market is saying the company’s whole is worth less than the sum of its’ parts.  (This is rare).
  5. The company maybe insolvent.  Model Price ™ has a solvency ratio calculation that we use.  We identify 3 forms of insolvency.  If the security has any form of insolvency, this warning sign (trading below EBV-3) will likely mean the equity price will go to zero.

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