Investors looking at
Goldman Sachs Group
have tended in recent years to focus on what’s missing.
It doesn’t have a big consumer business. It is not a major commercial lender. Its first-ever investor day in January generated limited excitement. Because of what investors have found lacking, shares of Goldman (ticker: GS) have languished at a low valuation compared with its banking peers, based on earnings and book value.
Overlooked has been Goldman’s strengths: strong risk management, a powerhouse investment bank, and a CEO, David Solomon, who is pushing to build an online banking franchise, broaden relationships with corporate clients, and expand a lucrative alternative-asset-management business, which includes private equity.
Goldman may never become a leading bank on Main Street. But given the uncertainty over a Main Street economy still struggling with the effects of the Covid-19 pandemic, the bank that is emblematic of Wall Street looks like a good bet for investors.
The firm is well positioned for the current environment, with a corporate and institutional focus and little exposure to consumer and small-business lending. And Goldman stands to gain from ultralow interest rates, unlike rivals whose margins are under pressure.
Its huge trading business had a blockbuster first quarter and could be on pace for a lucrative second quarter, capitalizing on market volatility and elevated volume.
“Goldman has less exposure to credit and interest-rate risk relative to the average bank,” says Mike Mayo, the banking analyst at Wells Fargo. “It has three times more capital per dollar of loans than the average big bank. “It’s one of the best risk managers in financial services, and its bread-and-butter investment-banking business is still best-in-class.”
Investors are starting to take notice. Goldman shares have outperformed those of rivals, falling 15% so far this year against an average drop of roughly 35% for
Bank of America
Goldman’s stock, now around $200, looks appealing, trading below its tangible book value of $215 a share and at a discount to most of its peers. The stock is no higher than where it traded in 2007. And the firm has a market value of about $70 billion, making it one of the smallest of the six largest U.S. banks. It’s less than half the size of online-payments leader
Mayo has an Overweight rating on Goldman and recently lifted his price target on the stock to $255 from $230.
“Goldman’s clout with governments, corporations, and investors around the world is as strong as ever, even while its relative market value has shrunk,” Mayo says. “Its market cap to clout ratio has never been lower.”
A key event to watch for Goldman will be the results of the annual stress tests of the top U.S. banks by the Federal Reserve on June 25. RBC analysts wrote this past week that Goldman may get the green light from the Fed to increase its dividend.
and Goldman Sachs, with big trading books and modest loan books, trading losses are the governing factor,” notes Eric Hagemann, a senior research analyst at Pzena Investment Management, which has held the stock for several years. “There was a severely adverse market environment in the first quarter, and there weren’t material trading losses. Can the Fed credibly model enormous trading losses in the stress test, given the experience in the first quarter?”
“That could be favorable for the capital requirements of Goldman and Morgan Stanley,” he says.
Goldman’s dividend yield is 2.6%. It has one of the lowest—and safest—dividend payout ratios among its peers based on projected 2020 earnings.
Stock buybacks, which Goldman and other large banks collectively suspended in March, are still unlikely in the coming year, however, amid a weak economy and depressed earnings for the industry.
Much has changed since the 151-year-old firm—public since 1999—stood astride Wall Street like a colossus. Regulations and capital requirements imposed after the 2008-09 financial crisis have crimped trading margins for banks. Technology has become increasingly important in finance. And the locus of power has arguably shifted to an asset manager,
The flat-lining of Goldman’s stock in recent years is a reflection of how the firm has wrestled with these changes.
“I would say that the strategy under the prior management was to not change who they were and wait for a better environment that would be more conducive to their traditional areas of strength,” Hagemann says.
Since Solomon took the reins of Goldman in October 2018 from longtime CEO Lloyd Blankfein, the bank has begun to pivot.
“Under Solomon, the view has been that if we’re going to be regulated like a bank, we might as well enjoy the benefits of a deposit franchise and a diversified set of revenue streams.”
Goldman didn’t make Solomon or its top executives available to speak to Barron’s.
There is periodic speculation that Goldman Sachs will merge with a large bank—recent talk involved Wells Fargo. That’s probably a long shot.
At a Bernstein presentation in May, Goldman President John Waldron played down the prospects of a “transformational” deal. “The bar goes up exponentially when we think about something that’s much larger or much more impactful to the whole of the firm,” he said, citing financial, cultural, integration, and execution issues.
Rather than merge with a bank, Goldman is creating one internally. It views itself as a Netflix-like disrupter in consumer banking because it lacks the high-cost network of branches that its larger competitors possess.
*50% from equities and 50% from fixed income, currencies,
Source: Goldman Sachs
Much has been written about Goldman’s Main Street push via its Marcus online platform and its relationship with
(AAPL). Less recognized is that Goldman’s focus has been to sharply expand its consumer deposit base to diversify its funding sources and go slow on growing its loan portfolio.
Its relatively low-cost consumer deposits accumulated online stand at $80 billion, up from $46 billion in the first quarter of 2019. Total deposits were $220 billion—including those from private clients and those raised in the wholesale market—at the end of the first quarter, some 31% of its funding base. It has been cautious on building up a consumer loan portfolio, which totaled just $7 billion at the end of the first quarter, or under 1% of its $1.1 trillion of assets. With a 13% reserve against those loans, they are unlikely to be a problem.
“Goldman never developed much of a consumer loan book, and the firm probably is feeling lucky the timing worked out the way it did,” says Pzena’s Hagemann. “Goldman can use it as a learning experience to see what the credit cycle looks like.”
Goldman’s total loan portfolio came to $128 billion at the end of the first quarter, less than 15% of its assets, and 78% of it was secured.
Some of those loans were taken out as liquidity precautions by corporations in the first quarter and then deposited back with Goldman, notes analyst Dick Bove of Odeon Capital Group. “They’re not really loans. It’s an ideal situation,” he says.
In a partnership similar to the one with Apple, Goldman will also be offering lines of credit to select small-business merchants on
Goldman has made heavy investments in technology, including electronic trading platforms.
That paid off during the Covid-19 lockdowns, when 98% of its global workforce of more than 38,000 was able to work from home and the firm handled enormous trading volumes in volatile markets.
Still, unlike many other big companies that are happy to perpetuate the work-from-home trend, Goldman believes that its culture is built on face-to-face interactions.
“Our firm thrives on connectivity, on collaboration, on teamwork, on learning from each other, sitting around a table, comparing notes on a problem and giving a solution to a client, which results in having a lot of people deliberating,” Waldron said last month. “We are anxious to get some of our people starting to come back to offices.”
Goldman’s top management is dominated by white men, but Solomon has said that he wants it and the entire firm to be more diverse, noting that clients want it, too. Some 63% of Goldman’s entry-level analysts last year were Asian, black, or Latino.
There are negatives. While its financial disclosure has improved under Solomon, Goldman remains a black box with hard-to-predict earnings, thanks to outsize trading operations and greater contributions from private-equity and other investments than those of competitors.
Trading generated 40% of net revenue last year; asset management, 25%; investment banking, 21%; and consumer and wealth management, 14%.
One of the Goldman’s biggest fans—Warren Buffett, who rode to the firm’s rescue during the financial crisis—has recently soured on the stock.
(BRK.A) reduced its Goldman holding by more than 80% in the first quarter.
Those sales seemed to reflect CEO Buffett’s conservative stance during the market meltdown. (Buffett did not respond to a request for comment.) Yet his imprimatur means less than it once did, given his uneven investment record over the past 10 years.
And still hanging over Goldman is the scandal involving Malaysia’s sovereign-wealth fund 1Malaysia Development Berhad, or 1MDB. Goldman raised $6.5 billion for the fund, from which several billion dollars were misappropriated. Goldman says, “We are continuing to engage with all relevant authorities.”
Wall Street expects Goldman to reach deals with both U.S. authorities and Malaysia, although Malaysia said last week that $3 billion was insufficient to settle the matter. Goldman has set aside $2.3 billion in legal reserves since 2018.
Even while dogged by the cloud of 1MDB, Goldman has laid out a brighter future. At the investor day in January, the firm presented a series of financial targets. Goldman seeks to generate a 13% return on equity and 14% return on tangible equity within about three years—goals that Waldron, the firm’s president, reaffirmed last month.
“Our earnings power could grow dramatically,” Solomon told investors in January. “So we have a great core franchise, which can grow, and a series of new business opportunities that are adjacent to our core.”
He said that Goldman could improve on its interim three-year goals of 13% return on equity and achieve “midteens” returns.
The goals outlined by Solomon don’t seem like a big stretch. The firm’s return on equity last year was about 12%, excluding $1.2 billion for litigation and regulatory reserves.
To help get to the targets, the firm says it aims to cut $1.3 billion in annual expenses, and reduce its funding costs by $1 billion a year, thanks in part to higher consumer deposits. It also is seeking to attract $100 billion in new investor money over five years for its alternative-asset-management business, including private equity.
The $2.3 billion in projected savings from expense cuts and funding should make the return targets achievable, Waldron said last month. “The numbers that we put out there that are in our control—largely in our control—don’t really rely on a revenue target or an operating environment, per se,” he said. If Goldman can get hit return goals, it would earn over $30 a share by 2022 or 2023, up from about $24 a share last year, adjusting for additions to litigation reserves.
Data as of 6/11/20. E=Estimate.
Pzena’s Hagemann says that Goldman is attractively priced at seven times what he views as normalized earnings. Goldman’s returns and earnings should hold up better than those of its rivals during 2020. It gets just 12% of its revenues from net interest income, against about 50% at JPMorgan and Bank of America.
The sharp drop in market rates is pressuring net interest income at rivals as yields on loans and securities come down. No relief is in sight with the Fed saying this past week that it expects to maintain near-zero short rates into 2022.
Goldman’s earnings this year are expected to total about $14 a share— and that estimate could easily prove low, given favorable market trends.
The firm sees a gradual expansion in its net interest income as it lowers the rate on its higher-cost retail deposits relative to banks. Goldman also lacks the big consumer and small-business loan exposure of its rivals.
During a stormy first quarter, Goldman earned $3.11 a share, down 46% from the year-earlier period. Its trading profits nearly doubled, but the firm added to loan-loss reserves and took some markdowns in its portfolios of private-equity, public-equity, and debt investments.
Odeon’s Bove says that current-quarter earnings, now expected to fall 45%, to $3.19 share, “could be surprisingly strong relative to Street expectations” in part because of strong trading.
Hagemann says that trading results correlate with market volatility, and by that measure, Goldman’s results from the first half could be some of the best since the 2008-09 financial crisis.
As a leading underwriter, Goldman is cashing in on record debt issuance from high-grade companies as well as equity deals. Merger activity has been light since the crisis, but could pick up later this year as corporate confidence rises. Goldman seems poised to benefit when that happens because of its top merger advisory platform.
Goldman has a $21 billion diversified equity portfolio, with about 90% of it private, on which it has earned impressive returns. It also has a $29 billion debt portfolio. The firm doesn’t say a lot about what is in those holdings, which include small stakes in
Wells Fargo’s Mayo says the risk-reward equation with Goldman is favorable, with the stock trading below tangible book value. That is a proxy for liquidation value, and it gives the firm no credit for its franchise and earnings power.
If Solomon’s initiatives continue to pan out and tangible book value approaches $250 a share by 2022, the stock could rally to $300 or higher as investors accord it a modest premium to tangible book.
“I’d give Solomon an incomplete grade so far,” Mayo says. “But at this valuation, as long as he gets a C-minus, the stock goes higher.”
Goldman’s qualities—and its inexpensive stock—should not be overlooked by investors. In an economy divided between Main Street and Wall Street, Goldman stands on the more promising block.
Write to Andrew Bary at [email protected]