Goldman Sachs: Is The Leopard Changing Its Spots?

| About: Goldman Sachs (GS)
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Before I begin, let me admit that I am a bit prejudiced against Goldman Sachs (NYSE:GS) just as I am against other U.S. banking companies that were part of an industry that was directly associated with the subprime crisis. When I hear people saying good things about these "giants of Wall Street" I just cannot stop thinking that a leopard cannot change its spots; or can it?

The Goldman Sachs Group Inc.

Goldman Sachs, a multinational banking company, is recognized as one of the premier investment banks in the world. Apart from investment banking, the company engages in a range of financial services, mostly for institutional clients. The company also provides underwriting services, asset management, prime brokerage and advice for mergers and acquisitions.

The bank got a lot of bad copy for its alleged improper practices during and immediately after the subprime mortgage crisis. From a peak of above $235 in October 2007, Goldman shares tumbled down to $53 in November 2008. Goldman Sachs received $10 billion under Troubled Asset Relief Program (TARP), part of the government's measures to address the crisis.


Goldman Sachs has beaten earnings estimates for seven out of the last nine quarters. In the most recent quarter ended March 2013, it reported an 11% increase in total non-interest revenue over the previous quarter. However, change from the same quarter prior year was only 2%. Maximum change was registered by the bank's operations in market making (27% over previous quarter). Overall growth in revenue could have been better had it not been pulled down by investment management (wealth management) operations, which showed a negative growth of 14%. On total revenue of $10.09 billion, which includes net interest income, the company reported earnings per share of $4.53.

Posting handsome profits (including consistent growth in net come) is not a problem with Goldman Sachs with operating margin of 35.70% and profit margin of 22.23%. However, the company is apparently not returning much of its income to shareholders and seems more interested in plowing its profit back into the business. It has a pretty low dividend payout ratio of 12.38% and a dividend yield of 1.44%.


Goldman Sachs' direct competitors include JPMorgan Chase & Co. (NYSE:JPM) and Morgan Stanley (NYSE:MS). Both banks beat market estimates by comfortable margins. Whereas Morgan Stanley beat EPS estimates by 7% ($0.61 against forecast of $0.57), JP Morgan surprised analysts by 15% ($1.59 against forecast of $1.9).

The market however showed an adverse response despite both banking companies showing better than expected results. Most of it has been attributed to worries about the future. Morgan Stanley, for example, has shifted its focus away from trading and investment banking and is more focused on wealth management. However, as Brad Hintz, banking analyst at Sanford C. Bernstein & Co says, the only banking sector that is doing well is investment banking. Mergers and acquisitions are up more than 20% whereas underwriting volumes have grown 30%. According to Hintz, this "will hurt Morgan Stanley, Schwab, Ameritrade and Bank of America (which bought Merrill Lynch)."

On the other hand, JP Morgan, which is one of the major mortgage banks along with Wells Fargo and Bank of America is experiencing a decline in revenues as demand for loans is limited and mortgage financing is slowing.

Leaving the past behind

Banking is more about managing available capital and building relationships than anything else. Goldman Sachs continues to score on "strong client franchise" across its businesses, emphasis on controlling expenses and efficient management of capital.

Whereas revenue for the full year ended December 2012 increased more than 18% as compared to 2011, the bank's operating expenses were more or less the same. Revenue growth is a reflection of a marked recovery in debt underwriting, M&A activity and the IPO market, particularly when seen in conjunction with more than 10% growth in first quarter 2013 earnings and sector wise revenue breakup.

Regulatory environment is another factor that is of importance to investment bankers. If there has been a lesson learned from the subprime mortgage crisis, then it is that the strength of the financial sector is a precondition for a robust U.S. economy. Sooner or later the regulatory environment has to change and be more supportive to growth. When that change comes about, that will be the time when large investors will readily pay more for Goldman Sachs, which is trading below its book value ($144.66).

While competitors are withdrawing from the Wall Street, Goldman Sachs continues to beat analyst estimates by gaining market share in trading and underwriting. I would suggest buying the stock now rather than wait. Once big market players start buying, the stock is likely to become costly.

We haven't come across negative copy on Goldman recently. Although it appears that the leopard is indeed changing its spots, I would still suggest that investors keep a close watch and be cautious if banks come up with the type of derivative products that led to the subprime mortgage crisis.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.