Tucked among some of the earnings misses from stocks that recently reported was a large earnings beat from storied investment bank Goldman Sachs (GS). Goldman’s third quarter EPS of $4.57 crushed estimates of $3.22. The market’s reaction? Investors initially drove the stock slightly lower on the news .
Though Goldman shares have since rebounded and risen steadily, trading recently at just over $180, a number of factors came into play which caused the market’s reaction. First, the market has been skittish about stocks given the Ebola scare, the European slowdown, and the fear that US business may not be or continue to be as robust as it has appeared. Beyond that, sometimes the earnings beat game gets confounded, as in, okay, so it’s an earnings beat, unexpected at that, but the market sometimes wants more. Maybe a lot more.
Goldman’s Strong Quarter
Still, Goldman’s quarter was impressive by most measures. Goldman posted net revenue of $8.367 billion for the third quarter, compared to $6.722 billion in the same quarter last year, although second quarter revenue was $9.125 billion. The revenue increase was led by gains in institutional client services, fed by fixed income (and a one-time gain), and rose in the year-over-year quarter by 32% to $3.77 billion. Added to this was a 26% increase in the investment banking sector, the division which includes IPOs.
Net earnings were similarly impressive, at $2.24 billion, compared to $1.517 billion in the year ago quarter. Even sequentially, the earnings handily topped second quarter earnings, which were $1.953 billion.The EPS of $4.57 was a substantial increase from the year ago quarter’s $2.88.
Goldman also increased its quarterly dividend to 60 cents a share from 55 cents a share and repurchased 7 million shares of its stock during the quarter for $1.25 billion. For additional flavor, Goldman had an upfront role in the Alibaba (BABA) glamour IPO—the one that created excitement that escaped the insular boundaries of Wall Street news and made it out to Main Street.
This is all good news, of course. So with all these positives, what’s not to like?
Beyond the general spooky feeling that permeates the market in the pre-Halloween batch of earnings reports, the market has some specific concerns about Goldman Sachs. Wall Street firm Morgan Stanley (MS) reported a terrific third quarter which included revenue from equity trading of $1.78 billion, compared to Goldman’s $1.46 billion in that department. This is the third quarter in a row that Morgan Stanley has topped Goldman in revenue from the equity trade, where Goldman has historically been the leader in the field.
Analysts also raised insistent questions at the Goldman earnings call about compensation. Compensation by Goldman’s was earmarked at $2.6 billion for the third quarter, yet this reflects a lower percentage increase than the company’s revenue increases, indicating Goldman is trying to hold down costs. The market’s take on this is that Goldman is showing a lack of confidence in the trading environment. Indeed, trading volume has been weaker for Wall Street firms this year. Add to this the ongoing concern about capital requirements and even renewed rumblings about more potential federal banking restrictions, along with questions about Goldman’s role in the recent Tibco-Vista Equity deal, and this is enough to build if not a wall of worry, perhaps at least a small fence.
What Should Investors Do?
Although the landscape of banking, including investment banking, has vastly changed since the financial crisis of 2007-2009, there is still substantial money to be made in the industry. While profitability is no longer as outsized liked the pre-crisis days, Goldman Sachs is still a formidable name with a global brand, arguably the best of a nearly vanished breed. Goldman still executes its business expertly. From 2011 through 2013, it grew revenue from $28 billion to $34 billion, income from $4.4 billion to $8.4 billion. Although growth is harder to come by now, Goldman continues to perform. The stock sells for 10 times earnings, in line with competitors such as Morgan Stanley.
The key for Goldman Sachs is if it’s able to continue to produce revenue and income growth even in the face of lackluster markets. The recent volatility may actually help with trading volumes, and the compensation issue may be one which eventually the market cheers as prudent cost cutting rather than pans as financial engineering. Also, unless there are new onerous banking regulations—and not just vague rumors, Goldman’s experienced leadership should be able to navigate the new more turbulent market waters. Investors should look at buying Goldman if it trades in the low $170s, nearer book value, as Goldman can be a long-term powerhouse stock.