- Goldman Sachs has performed poorly this year so far, owing to the systemic concerns rising around the industry.
- The bank will get the benefit of the boom in M&A deals, however, this will probably be offset by the decline in trading revenues.
- More optimistic signals need to be seen for a better stock performance.
Goldman Sachs (NYSE:GS) has performed poorly since the beginning of this year, owing to various settlements and fines weighing on the stock price that resulted in expectations to be reduced from Goldman and banks in general. Nevertheless, I believe that the stock has some upside potential; however, it is still not attractive enough.
The value of global mergers and acquisitions hit $1.75 trillion in the first six months of the year, a 75% rise on the same period last year. Roughly $750 billion of total transactions were made in the United States. Goldman Sachs has been the top advisor amid the boom in deals. Additionally, the initial public offerings pipeline continues to grow this year, which will also result in a solid increase in investment banking fees with the pickup we have seen in merger and acquisitions announcements so far.
On the other hand, developments on the investment banking side would be offset by the contraction in trading revenues. Wall Street banks are suffering a significant decrease in trading revenues due to slower activity in the market, which is evidenced by both the Volatility Index (VIX) hanging well below its historical averages and the stable outlook in currency rates. What drives the activity in Goldman's business is volatility, because the clients of the bank simply do not transact if the market is moving neither up nor down. Based on these developments, a decline of 20% in trading revenues is expected across the industry. In his presentation at Bernstein conference, COO Gary Cohn stated that the bank was gaining market share but the pie was shrinking, meaning no boost yet to revenues.
The above-mentioned catalysts are mostly likely to be priced in, but they will continue to characterize the earnings outlook for the next quarters. Therefore, I expect the company's revenue to remain flat or to grow weakly.
The key positive may be the increase in the bank's cross-border activities. The bank saw its business volume rise in Asia, and was ranked number one in the region so far this year by working on a record of $53.8 billion in deal-making. Emerging markets will likely present new major opportunities for Goldman Sachs.
Goldman Sachs definitely remains well-capitalized, and it has excess capital available to return to shareholders. The firm has begun to compute its capital ratio under the Federal Reserve Board's Basel III Advanced approach. The ratio was computed as 11.3% under this approach, which is above the targeted ratio of 9.5%.
Based on the catalysts mentioned above, I valued the company and tried to estimate a target P/BV ratio. Hereunder, the stock only offers 9.7% potential upside over the next twelve months, with a price target of $184, which is calculated by an estimated 10.6% return of equity ratio. Therefore, my recommendation for the stock is to hold at the moment. I will begin to see the stock as a play once the price reaches for better entry points.