In previous articles, I have said there are better financial firms to invest in than Goldman Sachs (GS). The firm recently released third quarter earnings, and I'm reviewing and updating my recommendation. That said, Goldman Sachs continues to trend higher even as the broader market begins to sell off. The firm is a laggard, and its year-to-date gain of almost 40 percent is a sign of its previously depressed valuation.
Revenue is on pace to increase this year compared to last year as forecasted. Third quarter revenue is reported as $10.1 billion. Revenue is calculated as non-interest revenue plus interest income. Third quarter net income increased compared to the second quarter. The net profit margin for the first nine months of the year is 15 percent. Investors should be decreasing long equity risk. In other words, selling on good news.
Investment banking revenue has been between $800 million and $1.6 billion during the period between the second quarter of 2009 and 2012. The top of the range is 100 percent greater than the bottom. In other words, investment banking revenue is volatile. Investment banking revenue declined from $1,206 million in the second quarter to $1,168 million in the third.
Investment management revenue peaked several quarters ago and then declined substantially. Investment management revenue increased in recent quarters and is expected to continue to increase. That said, investment management revenue declined to $1,147 million from $1,266 million in the second quarter.
Market making revenue is in a down trend. I expect market making revenue to continue to be below 2010 levels as the volume of trading of financial markets should continue to be light. That said, market making increased compared the second quarter.
Net interest income is in a down trend and should continue its down trend as the Federal Reserve continues to purchase financial assets to boost economic growth. Net interest income declined from $1.1 billion in the second quarter to $836 million in the third quarter.
Two of the larger segments, investment banking and investment management, should continue to increase revenue in the coming quarters. The largest segment, market making, should continue trending lower. Overall, the operating segment financial performance is mixed. That said, in the third quarter market making contributed to overall revenue growth while investment banking and investment management revenue declined.
Also, Goldman Sachs' return on equity declined between 2009 and 2011. The firm's management isn't generating the level of return on equity investment that they were prior to the financial crisis.
Most of Goldman Sachs' monthly returns are between +/-20 percent. Between 2006 and now, Goldman Sachs had a negative geometric mean monthly return. The standard deviation of Goldman Sachs' monthly returns is 10.4 percent.
Goldman Sachs' revenue is forecast to increase this year compared to last year. The full-year revenue-share forecast is $72.93. The twelve trailing months revenue-share is $67.78.
Overall, the third quarter was good, but revenue growth was driven by market making.
Federal Reserve Bank of St. Louis President James Bullard believes economic growth will pick up to 3.5 percent next year, pushing the unemployment rate down to close to 7 percent.
An improvement in the pace of economic growth would be bullish for shares of Goldman Sachs. The increase in economic growth would positively impact investment banking and investment management revenue.
Manhattan Wage Drop
Manhattan's average weekly wages fell 6.3 percent in the first quarter from a year earlier according to the Bureau of Labor Statistics. The drop in Manhattan was mostly attributable to a $5.3 billion drop in financial activity wages. Average weekly pay in that industry dropped 13.7 percent.
The industry accounts for 5.3 percent of New York City private sector jobs, about 7 percent of its tax revenue and about 14 percent of the state's revenue.
The securities industry accounted for 29.3 percent of New York City wages and salaries in 2012's first three months, down from 34.6 percent the prior year.
The decline in pay on Wall Street will have negative implications for the economy. However, the absolute number, $5.3 billion, isn't large enough to have a substantial economic impact. That said, it shows the cost control measures that firms like Goldman Sachs are putting in place to increase returns to shareholders.
Goldman Sachs Can Fall Off The Fiscal Cliff
Goldman Sachs has faced reduced competition from Morgan Stanley in trading, underwriting and private equity activities, which is contributing to the firm's current financial performance. That said, the last time Congress posed a risk to the US economy, bank earnings were destroyed. Business pulled back from merger activity and the financing of risk taking through bond and stock issuance. As a result, Goldman posted its first quarterly loss in over a decade.
The resolution of the fiscal cliff depends on the outcome of the election. Should either party dominate the election, the fiscal cliff should be resolved by the end of the year. If Congress is gridlocked after the election, the resolution of the fiscal cliff may take until the beginning of 2013. Also, if Congress is gridlocked, there could be a short-term solution to the fiscal cliff, but the probability is less than if either party wins control of Congress. All that said, honestly, I have no idea what Congress is going to do and that is part of the reason I believe uncertainty will weigh on market prices, including Goldman, in the coming weeks.
Goldman Sachs is short-term overvalued. Investors should use the solid earnings report as an opportunity to take profit.
Disclaimer: This article is not meant to establish or continue an investment advisory relationship. Before investing, readers should consult their financial advisor. Christopher Grosvenor does not know your financial situation and ability to bear risk and thus his opinions may not be suitable for all investors. I am short SPY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.