Hello criminal probe, goodbye hard-earned reputation — and, er, about seven per cent off Goldman Sachs’ stock, as at pixel time.

This note from a Merrill Lynch analyst says it all:

We are lowering our rating on GS to Neutral from Buy and our price objective to $160 from $220. Our downgrade is prompted by news reports filed Thursday evening by the media including the Wall St. Journal indicating that federal prosecutors have opened an investigation of GS in connection with its trading activities, raising the possibility of criminal charges.

As Guy Moszkowski explained:

PO of $160 discounts an ROE of 12%, by valuing the shares on 1.2x BVPS of $133 by the end of 10E. Though the firm’s long term earnings power is likely much higher, we expect the market to value shares at a discount given recent SEC charges and other negative headlines. Risks to PO: Earnings volatility, with GS registering ROE from negative in trough conditions to well over 20% in a peak market environment. Revenues can be lumpy. GS derives a high % of revenue from trading and market-making activities. GS’s business is balance-sheet intensive and has used high leverage which may be harder to carry as Bank Holding Co. While one source of GS’s ROE advantage is that it is good at spotting value, pricing illiquid assets, and taking risk, this means GS holds sizeable balances of illiquid securities subject to negative valuation adjustments. Going forward, inv’t banks and their leverage ratios will likely face greater gov’t scrutiny that could hinder returns. Given GS’s significant principal exposure, retracement of equity and debt market gains could result in losses.

GS is also exposed to headline and litigation risk. The firm has been under increased media and political scrutiny over the last few months.

Oh, S&P Equity Research cut Goldman to sell from hold.

The target price? $140 from $180.

The price of Goldman settling with the SEC over its civil fraud case in the first place? Probably worth it.

This entry was posted by Joseph Cotterill on Friday, April 30th, 2010 at 15:26 and is filed under Capital markets. Tagged with Equities, goldman sachs, merrill lynch, sec, securities fraud. Edit this entry.