Both JPMorgan (JPM) and Goldman Sachs (GS) report first quarter, 2013 financial results in the next few weeks, with JPMorgan reporting first, on Friday morning April 12th, before the market opens, and then Goldman Sachs following shortly thereafter on Tuesday, April 16th, before the market opens.
We think these two financial titans still represent the best-in-class of both the major banks and the investment banks, although the business and regulation has changed the financial intermediary landscape dramatically since the 2008 financial crisis.
Here is our quick look at each company's fundamentals and expectations for Q1 '13. Financials have corrected sharply the last few weeks, "pre-earnings," so the stocks have already pulled back to what we think are good levels to own.
What many think is or was the poster child for bad behavior is still not only alive but functioning well in the post-2008 environment, but one factor to GS's business model that we've struggled with is how much "prop trading" or proprietary trading was worth to GS in terms of earnings per share (EPS).
Current analyst consensus per ThomsonReuters data is looking for $3.84 for Q1 '13 EPS on $9.957 billion in net revenues for expected year-over-year growth of -2% and -4% ,respectively. Analysts have clearly reined in expectations for GS despite the SP 500 being up 10% for Q1 '13, while the credit markets were up 1% - 2% and Treasuries were flat.
Both EPS and revenue consensus estimates for Q1 '13 have drifted higher since the January '13 earnings report.
In Q4 '12, GS reported blow-out EPS of 51% upside ($5.70 vs. $3.60 consensus) on a 17% upside surprise in revenues. In addition in Q1 '12 last year, the SP 500 rose 15% (a lot of that was AAPL) and the credit markets were healthy. There should be less and less of a tailwind from credit markets and bond issuance (for refi purposes) as we move through the next few years.
Investment banks and trading firms have always been tough to model by sell-side analysts. I've followed the broker-dealers since the mid-1990s (GS didn't come public until 1999), and Wall Street has always underestimated results when the capital markets were a tailwind.
That being said, the "old" Goldman Sachs (in the mid-2000s) once had analyst consensus in terms of the forward estimates at one point looking for $25 per share in EPS, and my guess is prop trading was as much as $10 of this number, so as Wall Street has moved away from prop trading thanks to Dodd-Frank, there is less overall "earnings power" but a more stable, less volatile earnings stream.
So what is "normalized earnings" for a powerhouse like GS: my simple guess is that GS can earn, in normal equity markets, i.e., moderately higher stock prices with no credit widening, and flat to lower Treasury prices, probably (over time), $15 to $17 per share.
Current analyst consensus per ThomsonReuters for 2013 is estimating $13.85 in EPS on $34 billion in revenues, with a likely expected return on equity (ROE) of 10%.
Tangible book value is roughly $135 per share, while book value is roughly $145, so at 10(x) EPS for 2013 and an expected -2% drop in net revenues this year, expectations are still very muted for the investment banking giant.
Goldman has done a superb job of buying back its shares every quarter: we've been tracking its average share price repurchases every quarter and it has averaged close to the low every quarter, not to mention it is buying back shares below book value and tangible book.
For patient investors, we think GS offers good value near $140, and better value near $130. This is a different business than just 5 years ago, but earnings should be more stable, with steadier but lower growth.
Both our internal model and Morningstar value GS near $150, which I think is conservative given that peak earnings could be in the high teens, with help from the equity market.
The little known fact that doesn't seem to get much play on the Street for JPM is that even with the London Whale issues in 2012, (which make for easy compares through the June quarter) JPM still earned $5.20 in 2012, leaving the stock trading at 9(x)-10(x) earnings for 16% earnings growth, despite the headline bashing that we saw of Dimon and JPM all year.
For calendar 2013, current consensus per ThomsonReuters is looking for $5.81 in EPS on $100 billion in revenues for expected year-over-year growth of 11% and 1%, respectively. At $47 per share, JPM is trading at 8(x) current consensus on 11% expected growth.
For Q1 '13, analyst consensus is looking for $1.40 on $25.968 billion in revenues for expected y/y growth of 17% and -3%, respectively.
JPM's tangible book value is closer to the mid $30s, so it isn't as cheap on a book value basis as GS, and the fact is, I think JPM's earnings consistency is a little more durable than GS' in an uncertain environment. JPM was finally allowed by the Fed to repurchase stock with the latest Fed stress tests, that is another positive for the mega-bank.
We'd buy JPM here, although it becomes screamingly cheap in the low $40s. The whole London Whale issue over-shadowed what was a pretty good year for the bank, despite still tepid revenue growth.
Summary: With so many market watchers screaming for a correction with the SP 500 near all-time highs, you in fact have started to see profit taking in financials, and we think that spells opportunity for longer-term investors.
Both JPM and GS are "market-sensitive" financials, with P/L's influenced by capital market direction and sentiment. We expect both GS and JPM to report good quarters for Q1 '13, and we would use any weakness as a buying opportunity for the stocks.
For financials in general (using our sector data from ThomsonReuters):
1.) Forward estimates for financials are showing positive revisions (or at least far less negative revisions) than the rest of the SP 500 for 2013, better than almost any other sector for this year, probably thanks to both the recovery in housing and the ebbing of regulation, etc.
2.) Financials have lacked meaningful revenue growth as a sector off the '09 market low, and although EPS estimates have recovered and are once again growing, revenue growth is just starting to accelerate. With operating leverage in a lot of these banking models thanks to years of cutting costs, any kind of 3%-5%-7% revenue growth in the sector would be a huge plus for EPS.
3.) Some think given that Fed permission is needed to pay dividends and repurchase by the banks, that financials are now similar to regulated utilities. There is some truth to that, but as housing markets recover, and with regulators crawling all over the banks for the past 5 years, these could be construed as safer institutions, with a more dependable earnings stream.
At roughly 17% of the SP 500 by market cap, financials aren't to be ignored. We think JPM and GS are still "best-in-class." We remain overweight financials in client accounts, and long these two names specifically, with room to buy more lower, if the opportunity arises.