Is Goldman Sachs a Strong Buy Right Now?
Maxwell is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Goldman Sachs (NYSE: GS) had its typically tumultuous quarter in the first quarter of 2012. If nothing else, there is never a dull moment here. Of course, in the first quarter, Goldman had on its plate general sluggishness in the investment banking business in which it operates, Greg Smith's scathing excoriation in the New York Times, and the pending impact of the Volcker Rule. Through it all, Goldman Sachs reported quarterly earnings of $2.1 billion, or $3.92 per share. Some are virtually jumping for joy at the “rebirth” of Goldman Sachs. Let’s do a reality check.
Certainly, the quarterly profits look terrific compared with both the first and fourth quarters of 2011. As the investment bank climate began showing signs of its inevitable cyclical recovery, Goldman Sachs rode the wave to profits that more than doubled both the first quarter of 2011's $1.56 per share, and the fourth quarter of 2011's $1.84. The comparison with the first quarter of 2011 is skewed due to the fact that Goldman Sach's preferred stock dividend requirements declined nearly $1.8 billion between the two periods. Much of that inflated year ago preferred dividend amount was due to Goldman Sach's redemption of Warren Buffet and Berkshire Hathaway's investment that was made early in the recession. If one takes away that one time event, earnings fell 23% in the 2012 first quarter versus the 2011 first quarter.
Let’s break this down to a unit by unit comparison. On the revenue side, when comparing the first quarters of 2012 with 2011, investment banking was down by 9%, with a steep decline in equity underwriting, partially offset by a pickup in financial advisory fees. Institutional Client Services revenues were off 14%, Investing and Lending were off 29%, and Investment Management was off 8%. Revenues in general were down 16%. But at the same time, revenues look great compared to the previous fourth quarter of 2011, up an aggregate 64% from the dismal fourth quarter of last year. I have a reasonable degree of confidence in concluding that the fourth quarter of 2011 was the nadir of the down cycle for the investment banking industry, and look for a much improved environment in 2012 and 2013. The only true caveat to that is the European economy, which may prove a substantial headwind for a while longer.
Goldman Sachs' earnings have always been as volatile as any large, publicly traded company, even more so than say, steel or auto. Earnings per share for full years 2005 through 2011 have been $11.21, $19.59, $24.73, $4.47, $22.13, $14.90, and $4.50. For 2012, analysts are looking at $12.17 per share, and based upon the first quarter and trends in the industry, I think realistically $14 per share is a better guess.
Goldman Sachs has as much ill will as any company in the country at this time. Its flaunting of convention, lack of humility, enormous TARP bailout, and its very role in creating the conditions that led to the financial mess that created the recession mean it will likely be a poster child of greed for populist politicians in the upcoming election cycle.
The biggest recent news involving Goldman Sachs, for a change, was not litigation related. In April of this year, it partially unloaded its $5 billion stake in Industrial and Commercial Bank of China, LTD. Much of its uglier litigation is behind Goldman Sachs, and if you can put up with its extraordinary volatility, the trend for the company should definitely be up over the next two years or more.
Goldman Sach's recent high stock price was just over $250 per share in 2007. That is a reasonable goal over the next few years. Be aware though, no bank delves as deeply or as successfully (usually) in proprietary trading as Goldman Sachs. The Volcker Rule is virtually targeted at Goldman Sachs, and if it passes, it will be a big negative. I am confident though that even if it does pass, it will be hugely weakened from what the former Fed Chairman originally intended.
Morgan Stanley (NYSE: MS) is Goldman's chief domestic competitor. As such, many of the issues that affect Goldman Sachs affect Morgan Stanley as well. Morgan Stanley has never been quite as high flying as its larger peer, but is still hugely impacted by market conditions in its core investment banking unit. In the first quarter of 2012, Morgan Stanley actually posted a loss of five cents per share. In recent quarters, the firm’s income statements have been increasingly dominated by Debt Valuation Adjustments, alternately positive or negative. The loss in the first quarter of 2012 was occasioned by a nearly $2 billion negative debt valuation. Absent that factor, as well as all prior Debt Valuation Adjustments, and a clearer picture emerges. In the first quarter of 2011, earnings were $866 million, and in the fourth quarter of 2011, probably the low point for the investment banking industry, Morgan Stanley lost $381 million. In the recently concluded first quarter of 2012, earnings were $1.34 billion, or $0.71 per share. This easily beat analysts’ expectations of $0.44 per share, and revenues also exceeded expectations.
Even more so than Goldman Sachs, Morgan Stanley is selling at a huge discount from its 2007 peak of almost $91 per share. As such, I believe it has even more upside, and more appeal to investors.
Several large, money center banks such as JPMorgan Chase and Citigroup also carry sizable investment banking operations that also suffered greatly in the second half of 2011. If the investment banking business indeed improves, it will be a huge profit boost, to JPMorgan in particular. But the fact is that banks like JPMorgan and Citigroup are less volatile than pure investment banks because their commercial bank operations dilute the impact of that volatility.
Despite a tumultuous first quarter, Goldman Sachs is in position to rise in the coming quarters. With most of the litigation issues behind it, I expect continued gains to finish 2012. Investors should watch the impacts of the Volcker rule closely as Goldman Sachs eases in, but I see no compelling reasons not to take a position in Goldman Sachs now.
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