Goldman Sachs Earnings – Behind the Headlines

By Chad Henage - July 21, 2012 | Tickers: GS, JPM, NES.DL | 0 Comments

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You can tell that the stock market has had a rough few months, based on the earnings released by Goldman Sachs (NYSE: GS). After all, when you're an investment bank, and investments aren't doing well, it's tough to make a lot of money. That being said, the company is doing what it can to boost earnings, and the stock appears to be selling at a discount to its true worth. Though the headline numbers are not that impressive, there are a few reassuring statistics when you go behind the headlines.

Headline Earnings

What's interesting about Goldman Sachs' recent earnings, is they confirm a trend that has been reported on a regular basis. That trend is, that investors are increasingly putting funds into money market accounts and fixed income and avoiding equities. With non-interest income down 5.6%, and interest income down 23%, you can see the challenges that Goldman faced this last quarter. Since the company reports in essentially four different divisions, let's look at each to see how things are going.

Investment Banking

This division saw net revenues decrease 17%. Financial advisory revenues dropped 26%, which was a reflection of less merger and acquisition activity. Underwriting revenues also decreased 9%, which was actually split between underperformance in equity underwriting, and outperformance in debt underwriting. Clearly Goldman has a challenge when it comes to equity underwriting, as revenues in this part of investment banking were down 37%. However, and also not surprisingly, debt underwriting increased 14%. Very low interest rates, and companies issuing long-term debt to lock-in lower interest expense, are two primary reasons that debt underwriting increased as much as it did.

Institutional Client Services

Repeating the same theme from investment banking, institutional client services saw fixed income outperformance and equity underperformance. Net revenues for this segment increased 11%, led by a 37% increase in fixed income, currency, and commodities execution. With a challenging equity market, equity revenue dropped 12% due to lower commissions, and lower execution income.

Investing & Lending

The company did not give a lot of information about this division, except to say that revenues decreased. It's interesting, because if you read the financial statements you can see why Goldman Sachs chose not to elaborate on this division's performance. In fact, to say this division's revenue decreased is a massive understatement, as the year-over-year decrease was over $800 million, or the equivalent of a better than 80% decline.

Investment Management

This division showed revenues increasing 5%, which was driven significantly by bond and money market investments. Keeping with the theme of investors aversion to risk, the company's assets under management increased by $12 billion, but without equity and commodity outflows, this increase would've been better than $16 billion. As proof that investors are choosing bonds and money market accounts, consider that Goldman Sachs' assets under management show fixed income at 43.42% of the total and money markets representing 25%.

Financials

As proof that Goldman Sachs is doing as much as it can to improve earnings in the future, consider that operating expenses were 8% lower than last year, and 23% lower than the first quarter. In addition, the company said they are “in the process of implementing additional expense reduction initiatives.” With the company's tangible book value over $126, and about 9% of diluted shares retired versus last year, the firm is doing about as well as it can given the challenging environment. In fact, during the current quarter, the company repurchased over 14 million shares at an average cost of $104.81. Goldman still has over 46 million shares available to be repurchased under its existing buyback program. So the only question left is, should investors look at this as a buying opportunity?

Competition and Conclusion

In this case, it's instructive to compare Goldman Sachs with two of their primary competitors. Those two competitors are JPMorgan Chase (NYSE: JPM), and Morgan Stanley (NYSE: MS). Since both companies compete directly with Goldman not only for investment dollars, but also for underwriting privileges, some investors might look for the best opportunity among the three and just buy that stock. With Goldman Sachs selling for a forward P/E ratio of 9.51, and expected to grow at 14.35%, the stock looks like a decent value. However, investors can get similar numbers at Morgan Stanley, which sells for a forward P/E ratio of 11.75, and is expected to grow at over 17%. With both of these investment banks paying very similar dividends, some investors might flip a coin and just choose one. However, there is one statistic that seems to define the difference in relative value between these two companies. If you look at each company's book value, Goldman Sachs sells for 0.73 times book value, yet Morgan Stanley sells for just 0.46 times book value. Because of this, it appears that Morgan Stanley could be the more attractive opportunity. For investors looking for a better dividend, that also sells for less than book value, JPMorgan Chase would be a logical choice. With JPMorgan paying a dividend of about 3.3%, selling for about 7.5 times 2012 earnings, and expected to grow by about 7%, this more traditional bank looks attractively priced as well. The bottom line is, if investors want a pure play on an asset manager, I would go with Morgan Stanley. If investors want a strong asset manager, inside of a traditional bank, JPMorgan is the way to go. While there's nothing inherently wrong with Goldman Sachs, it just appears these other two options are more attractive.

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