Goldman Sachs is a high quality cheap stock...

Goldman Sachs is not a company that needs an introduction.  Here is a description:

"The Goldman Sachs Group, Inc. is an investment banking, securities and investment management company that provides a range of financial services to corporations, financial institutions, governments and individuals. The Company operates in four business segments: Investment Banking, Institutional Client Services, Investing & Lending, and Investment Management. The Investment Banking segment consists of financial advisory and underwriting. The Institutional Client Services segment makes markets and facilitates client transactions in fixed income, equity, currency and commodity products. The investing and lending activities, which are typically longer-term, include its investing and relationship lending activities across various asset classes, primarily debt securities and loans, public and private equity securities, infrastructure and real estate. The Investment Management segment provides investment and wealth advisory services. As of December 2016, it had offices in over 30 countries."

Goldman announced quarterly results last night and the stock sold off based on tepid growth in various business lines.  Short term disappointment really.  That's not what this note is about.  I have no idea what the short term holds for the global economy or Goldman Sachs.  My goal is to discuss the quality of Goldman's earnings, and also the low multiple it currently trades at.  I'm going to argue it deserves a higher multiple.

Let's look at how Goldman Sachs has done over the last few years.  From the 10K: 

2016: $30.6 billion in revenues, $10.3 billion pre-tax net earnings
2015: $33.8 billion in revenues, $8.8 billion pre-tax net earnings
2014: $34.5 billion in revenues, $12.4 billion pre-tax net earnings

There are a lot of moving parts underlying this, as Goldman Sachs is a big diversified business.  Granted it is a financial services company and all its business lines are correlated to economic activity to a great extent, it still is the life blood of the global economy through its various business lines.  Goldman Sachs is a brokerage and partakes - in a similar spirit to Visa and MasterCard - in a large swathe of economic activity.  Anyone who has been investing for any significant period of time will tell you that you do not generate pre-tax net income margins of 35% without offering a very valuable service.  These margins are very juicy in the world of investing.  Any investor will take note.

Let's quickly look at what this high quality business is valued at right now: $90 billion.  So last year, GS did $7.3 billion of net income after tax.  Analysts are projecting 2017 E at $7.9 billion.  So 11X NTM EPS.  Is that cheap?  The answer is complicated.  I believe so.  I think 15X is more fair, since I believe Goldman is likely to continue to compound bottom line EPS nicely over the next few years.  Of course, this relies on steady economic growth, and an acceleration would be even better, but economic growth is largely unpredictable, so there is very little point in discussing it.

Back to the P/E multiple.

P/E multiples don't mean anything.  Stocks can trade at 1000X NTM EPS (e.g. Netflix, Amazon at one point historically) or 2X NTM EPS (e.g. Valeant, Endo currently).  What is required is that the P/E multiple is paired with a deeper understanding of the underlying dynamics of the business.  This means we have to understand the moat around the business, sustainability of earnings, the cost of capital, competition, potential cyclicality, potential for technological disruption etc.

Ben Graham has a great quote on this front: "You don’t have to know a man’s exact weight to know that he’s fat.”
Amazon and Netflix are valuable enterprises.  Are they worth $400 billion or $60 billion respectively?  I have no clue.  But they are valuable, given the service they provide, the durability of their moat, and their customer focus.  Valeant and Endo are debt laden enterprises that offer ordinary products at prices that arguably are inflated.  (To be sure, Valeant does own Bausch & Lomb, which is a high quality consumer products company).  But neither Valeant nor Endo are particularly valuable, apart from the once popular carry trade both were able to implement thanks to a conducive drug price environment.  You don't have to know a man's exact weight to know that he's fat.

Back to Goldman Sachs.  Goldman Sachs is a high quality company.  While it is not a bank, Goldman does have leverage due to the financial intermediary and balance sheet heavy nature of its business.  This is not a capital light business by any means.  While this is not ideal (since leverage almost always results in some crisis at some point in the life of a business), the core operations are a necessary evil for the modern economy to operate.  Obama really captured the essence of Goldman Sachs' business during the  annual White House Correspondents Dinner

“All of the jokes here tonight are brought to you by our friends at Goldman Sachs,” Mr. Obama said, referring to the SEC allegations. “So you don’t have to worry — they make money whether you laugh or not.”
And that is important. 

Goldman makes money as long as the economy functions.  It makes more money as the economy grows.  11X for a company earning 35% pre-tax margins is too cheap in my opinion.  Granted we could see an economic slowdown, or muddling growth, and in that case Goldman Sachs' stock will fall, just like almost every other company.  But if you look at Goldman's business, it is a high quality service oriented one.  Goldman is also buying back stock at these prices, so that's a nice return of capital at a low multiple.

So maybe Goldman Sachs doesn't deserve a 24X multiple like Visa.  But it does deserve a better multiple than 10-11X, especially since if we do see rising rates and a faster growing economy, EPS will compound very nicely over the next few years. 

J. Jill - an apparel retailer with upside...

With all the doom and gloom surrounding the apparel sector - particularly, brick and mortar retailers - it might seem odd to be bullish on a women's apparel company.  But that is what I am going to do in this note.  I believe women's retailer J. Jill has upside.  First, a description of the company:

"J.Jill, Inc. (J.Jill) operates as a specialty retailer in the women’s apparel industry. J.Jill is a women’s apparel brand focused on customer in the 40-65 age segment. The Company operates an integrated omni-channel platform that is diversified across its retail stores, Website and catalogs. It operates in the retail and direct channels segment. Its direct channel consists of its Website and catalog orders. As of January 28, 2017, it operated 275 stores in 43 states. The Company also offers a range of footwear and accessories, including scarves, jewelry and hosiery. Its products are marketed under the J.Jill brand name and sold through its direct and retail channels. It offers two sub-brands as extensions of its brand aesthetic: Pure Jill and Wearever. Its Website provides customers with access to the J.Jill product offering and features content, including updates on new collections and guidance on how to wear and wardrobe its styles."

J. Jill is not a fast growing retailer that will take over the world.  Revenue growth over the last year was a meek (perhaps reasonable) 13.7%.  Consensus pegs revenue growth over the next year at 9.9%, and 8.8% the following year.  The big positive here is that it is a retailer with a laser sharp focus on profitability.  Here's the key detail:

J.Jill focuses on females in the 40-65 age group.  Their customer base has some very desirable characteristics.  As they described in their S1: "Our customer is 40-65 years old, is college educated and has an annual household income that exceeds $150,000.  She engages across both our direct and retail channels and is highly loyal, as evidenced by the fact that approximately 70% of our gross sales is pro forma 2015 came from customers that has been shopping with J. Jill for at least five years."

In their 10K, J.Jill describes why they are different:

1) Distinct, well recognized brand
2) Industry leading Omni-channel business
3) Data-centric approach that drives consistent profitability and mitigates risk
4) Affluent and loyal customer base
5) Customer-focused product assortment
6) Highly experienced leadership team, delivering superior results

J.Jill currently has 275 stores in 43 states.  They project that they could potentially increase their store base by about a 100 over the long run.  But this is not the reason you want to invest in this company.  The reason you want to invest is because this retailer has good economics, which will grow EPS nicely over the next decade or so - if business holds up.  The latter is always a consideration in fashion retailer, so that will have a big influence on shareholder returns too.

And business is holding up well.  Company comparable sales were up 11.2% over 2016. 
J. Jill was taken private and recently IPO'd.  It is saddled with $267 million of debt, so as they pay down these obligations, value should accrue to equity holders.  In addition, there may even be share repurchases in the future, if all goes to plan. 

The stock currently trades for 14X NTM EPS, which seems reasonable but not excessively cheap.  However, with steady profitable growth (through SSS growth and opening new stores), J. Jill might be able to compound the bottom line at 20% for some time going forward - given favorable economics. 

It's worth going long here IMO at $13.6 per share and a market cap of $600MM.  This could provide a decent, albeit not spectacular return, over the next few years...

Trivago is a risky stock...

"Trivago NV is a company based in the Netherlands that operates an online hotel search platform. The platform allows users to search for, compare and book hotels. It gathers information from various third parties' platforms and provides information about the hotel, pictures, ratings, reviews and filters, such as price, location and extra options. The Company offers access to approximately 1.3 million hotels in over 190 countries via more than 50 localized websites and applications in various languages. The Company also offers marketing tools and services to hotels and hotel chains, as well as to online travel agencies and advertisers, among others. Its principal executive offices are located in Germany."

We have all seen commercials where the Trivago guy tells us how he can help us find a good hotel deal.  And that is a great idea; we all want super low rates on hotels and that is why Airbnb has been such a winner.  Priceline is the online aggregator of great deals for hotels, air flights, so its a nice concept. 

Except, the problem with Trivago is that it aggregates data from aggregators.  For example, hotels.com aggregates the best hotel deals from around the world.  Trivago then sends you to hotels.com to book a room.  In other words, Trivago is an unnecessary layer between the hotel and booking site.  And it generates hits through aggressive advertising. 

Over 2016, Trivago spent $730 million on advertising!  And it generated a total of $754 million of revenues.  I don't see how this is a great business model and why this company should be valued at $2.9 billion!

Granted they are growing rapidly.  And I think the bullish thesis is that - at some point - brand awareness kicks in and Trivago becomes the Google of Hotels.  The only problem is that Google is the Google of Hotels!  And if not Google, then certainly hotels.com or bookings.com. 

I think there are too many problems with Trivago's business model for it to be a long term success.  The ROICs for this business are going to be low, and margins are going to be even lower.  I thin Trivago is expensive!