I've been applying for summer internships and going to networking events in the last few months and become somewhat acquainted with Goldman Sachs (GS) throughout the process. The firm is widely seen as the cream of the crop in investment banking and the fundamentals and valuation didn't look too shabby from a glance, so I figured I'd take a closer look. I assume most of the investment community is already at least somewhat familiar with Goldman, so I'll keep this brief.
The Business is Trending Well
The following are meaningful highlights from the Q4 2013 results:
- Goldman's investment banking once again ranked #1 worldwide in M&A and Equity in 2013.
- AUS +8% for 2013 and +5% QoQ
- 2013 ROE 11% improvement over 2012 10.7%. Q4 '13 annualized ROE is even better at 12.7%.
- Average Daily VaR down to $80mm in 2013 from $86mm in 2012
- Book value up 5% YoY and TBV up 7%
- Tier 1 Capital 16.7%
Strong Capital Management
The company has been repurchasing a significant amount of shares with excess capital. In Q4, $1.4B was spent to repurchase 8.5mm shares. For the year, $6.17B was spent to repurchase 39.3mm, or 8%. In the last 3 years, the company has repurchased a total of 83.5mm shares, or 17.1%. They're also paying $2.20 in annual dividends. Despite all this return of capital, the company maintained its healthy capital ratios from the prior year. Tier 1 Capital (Basel I) was 16.7% at the end of both 2012 and 2013.
Difficult Operating Environment
The results are not stellar but they are pretty impressive compared to other major investment banks and considering the operating environment. In the Q4 call, CFO Harvey Schwartz described all the uncertainty that the company's clients faced in 2013. He mentioned several sources of economic uncertainty including:
- Unrest in the Middle East
- 16 day US government shutdown
- Central bank activity, specifically QE taper
I think these are fair excuses to some degree. I would certainly consider the economic dynamics of the last 6 years to be atypical and I was definitely a little confused with the market dynamics of last year.
The slide below comes from a GS presentation from before the Q4 release, but I think it illustrates the impact of the all the uncertainty fairly clearly:
For a market maker business driven on commissions and fees and in turn, largely volumes, it is fair to feel a little sympathy. With the expectation of healthier volumes in the near future, the company has significantly increased operating leverage in the last few years and should benefit when things become more stable and the volume comes back, which I think it will once central banks take a gentle step back.
This is something I couldn't help but mention. I am a big advocate of incentivized, fair pay. 2 and 20 hedge fund pay bothers me because of how statistically unlikely it makes after-fee market outperformance. So does consistently high executive pay that only increases, even when the company is performing poorly and not paying its shareholders. Goldman and investment banks in general have been criticized about pay excesses, but I think the company has done a decent job containing expenses and the degree to which pay correlates with the company's performance is really admirable.
Analysts were looking to get a firm ROE target out of Schwartz, but he didn't budge, though he insisted that there was more room for improvement. Until we see more, I'm going to play it conservative. With trailing ROE of 11%, Q4 annualized ROE of 12.77%, and 5 year average ROE of 12.11%, I'm going to assume 12.5% in my dividend discount model valuation for the next 5 years, 10% thereafter. I also assumed a cost of equity of 10%. I got an estimated value per share of $187.95, 13.45% above market. That price would put the stock at 1.23x book value, consistent with my general rule that fair value for financial stocks is a P/B multiple that is 10-11x normalized ROE. The company has traded at an average P/B multiple of 1.064 in the last 5 years and currently sits consistent with that at 1.09x. The stock looks pretty cheap. The share repurchases supports that notion, as does a recent insider retaining 29k/38k shares of exercised options on Jan. 27. I've looked to temper my expectations in looking for insider buys in banking. Most insiders just don't do it or are prohibited from doing so because of all the red tape involved, so I found that a little meaningful. It's not cheap enough for me to buy, however. I look for at least a 30% margin of safety on initial entries, so I wouldn't buy unless it got down to $145, which is wishful thinking at this point.
Goldman Sachs put up some decent, underrated numbers in Q4. The business is very healthy and has performed well despite a somewhat difficult operating environment in the last few years. The company is structured well, an industry leader, and things should improve in the next few years as we finally reach the new "normal." I think the stock is moderately cheap; cheap enough to deliver a 15-20% return this year and 10% thereafter, but I'd like to see a better price. I will be keeping an eye on this one.