Don’t Buy the Wall Street Hype

By Karen Rogers - July 20, 2012 | Tickers: BAC, C, GS, JPM, NES.DL | 0 Comments

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As each investment bank reports their earnings, Wall Street analysts decry that now is the time to buy while the stock price is low.  Industry pundits point to Goldman Sachs’s (NYSE: GS) financials and rate the company as an undervalued buy at the current price.  At first glance they appear to be right:  the company has dropped 30% from a 52-week high of $139 to its current price of approximately $94, and the stock is trading at about 65% of book value.  Goldman Sachs investment banking and asset management net profit margins are over 10%, and some analyst are calling for the stock to hit $200 a share.

But numbers alone don’t tell the whole story.  The economic factors that propelled Goldman Sachs, Morgan Stanley (NYSE: MS) and other investment banks to stratospheric profits in 2006 officially ended when JPMorgan Chase (NYSE: JPM) bought Bear Stearns at a federal government fire sale in 2008.  Frank-Dodd and other financial regulations meant to reduce risk have also reduced investment banking revenue, and the days of easy cash and a hot housing market are gone.

Goldman Sachs ROE has steadily decreased yearly from its August 2007 high of 33.71%.  In December 2010, ROE stood at 13.1%; a year later, it dropped to 3.66%.  Earnings before interest and taxes went from $26.3 billion in December 2009 to $19.7 billion in 2010 before falling to $14.2 billion in 2011, respectively.  

Morgan Stanley is staring at the same erosion in value as Goldman Sachs: their first quarter 2012 investment banking sales and trading income declined15% to $3.2 billion when compared to their first quarter 2011. During their go-go days, Morgan Stanley’s ROE was 20%; in 2009, it was 9% and in 2011, fell even further to 5.4%.

Even JPMorgan hasn’t escaped the turndown in investment banking. The London Whale aside, the bank reported second quarter 2012 investment banking fees of $1.2 billion, a 35% decline from the same quarter 2011.  Second quarter 2012 net income is $1.913 billion, down 7% from $2.057 billion in the same quarter 2011. December 2011 ROE stood at 9.55%, a little less than December 2010’s 10.2% but still far below their September 2007 high of 14.43%.

Street analysts likewise are singing Citibank’s (NYSE: C) praises despite the recent Moody’s downgrade.  Like Goldman Sachs, Citibank is just coming off its 52-week low and is trading at about 46% of book value.  But Citibank has also seen its ROE erode from a September 2007 high of 15.21% to -27.50% in December 2008; first quarter 2012 ROE came in at 6.4%.  The companies EBIT continues to fall: $86.58 billion in 2006 to $40.48 billion in 2011.

And investors shouldn’t get too excited about Citibank’s financials released today.  Although this second quarter’s $0.95 earnings per share beat the $0.89 estimate, Citibank’s investment banking income fell 21% and equity underwriting fees dropped a whopping 39% compared to their first quarter.    

Bank of America (NYSE: BAC) continues to struggle with its Merrill Lynch purchase.  EBIT dropped to $40.48 billion in 2011 from $86.58 billion in 2006.  ROE saw a recovery from a second quarter 2011 low of -6.9% to -1.76% in first quarter 2012, both a far cry from the September 2007 high of 14.90%.

Goldman Sachs, Bank of America and Morgan Stanley are scheduled to release their earnings this week.  If the significant decrease in investment banking revenues posted by JPMorgan and Citibank are an omen, investors might want to ignore the Wall Street hype and take a wait-and-see approach as the banks continue grappling with shrinking revenues and faltering world economies.  

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