Company Reports

Investment banking revenue is recovering from recently depressed levels, but it was overshadowed by exceptionally strong trading results. Goldman Sachs reported net income to common shareholders of $3.9 billion, or $11.58 per diluted share, on $14.2 billion of net revenue. Investment banking revenue increased 32% from a year ago and 26% from the previous quarter to $2.1 billion. However, commissions and market-making revenue of $7.1 billion was about 8% higher than the previous year and 60% higher sequentially. Annualized return on equity for the quarter was 14.8% and return on tangible common equity was 15.9%. We don't anticipate making a material change to our $417 fair value estimate for narrow-moat Goldman Sachs and assess that shares are fairly valued.

We are increasing our fair value estimate for narrow-moat-rated Goldman Sachs to $417 from $368 per share. This is about 12 times forward earnings and 1.4 times tangible book value. About $10 of the increase is from earnings since our previous valuation update, with the remainder from miscellaneous adjustments, such as higher client assets under supervision, forecasting less of a decline in trading revenue, and incorporating estimated benefits to expenses from a restructuring of the company's consumer credit business.

Goldman Sachs is refocusing the initiatives it’s been working on the previous several years. At its 2023 investor day, it emphasized three priorities. In its investment banking and trading business, it wants to maximize client wallet share and grow its financing business. In asset and wealth management, it wants to grow its management fees, including in wealth management and raising third-party capital for its alternatives business. In its new platforms business, it wants to scale and achieve profitability.

A soft landing for the U.S. economy and recovery in capital markets would be a positive for the majority of Goldman Sachs’ business lines, but the company has a heavy weight to trading that doesn’t always move in the same direction as the economy. Goldman Sachs had a decent 2023, given the uncertainty in the economy and the company’s refocusing on its core investment banking and investment management businesses. 2023 net revenue of $46 billion decreased 2% compared with 2022 and was 22% lower than the unusually strong 2021 result. The fourth quarter of 2023 didn’t showcase particular strength; net revenue was down 4% sequentially as negative seasonality in fixed-income, currency, and commodities trading offset positive seasonality in investment banking and gains on equity investments. For the full year, the company had earnings per share of $22.87 and a return on tangible equity of 8.1%; if unusual items were excluded, return on tangible equity would have been about 10.7%. We don’t anticipate making a material change to our $368 fair value estimate for narrow-moat-rated Goldman Sachs. We assess the shares as fairly valued.

With interest rates at or near their peak and the increasingly popular view that the United States will avoid a recession, investment banking revenue is poised to rebound from recent lows. However, given the record levels of investment banking and trading revenue that U.S.-based banks booked in 2020 and 2021, there's an open question with regard to the reasonable level that investment banking revenue recovers to. While we don't believe that investment banking revenue will reach 2020-21 heights in the foreseeable future, we do believe that U.S.-based investment banks should have consistently higher revenue than they had before the COVID-19 pandemic due to the pullback of Europe-based banks.

Goldman Sachs continues to execute its plan of refocusing on its investment banking, trading, and investment-management businesses as it divests more of its consumer-facing operations. The company reported net income to common shareholders of $1.88 billion, or $5.47 per diluted share, on $11.82 billion of net revenue in the third quarter. Most of its revenue lines have been stuck in a range for the previous 1.5 years, with third-quarter revenue in the global banking and markets segment and asset and wealth segment and total net revenue within about 5% of the quarterly average since the second quarter of 2022. Excluding some arguably unusual items, such as losses on principal investments and expenses related to business divestitures, adjusted EPS would have been about $7.88 and annualized return on equity would have been 10.2% for the quarter. We don’t anticipate making a significant change to our $368 fair value estimate for narrow-moat-rated Goldman Sachs. We assess the shares as slightly undervalued.

We are decreasing our fair value estimate for narrow-moat-rated Goldman Sachs to $368 from $410 per share. This is about 12.5 times forward earnings and 1.3 times tangible book value. Earnings since our previous valuation update were more than offset by a lowering of our forecast growth for net interest income and lower operating margins. Our base case has net revenue growing at a compound annual growth rate of around 1% over the next five years, operating margins of 37.5%, and returns on tangible common equity of around 12.5%. The company has an operating margin goal of around 40% and return on tangible common equity goal of 15% to 17%.

Goldman Sachs is refocusing the initiatives it’s been working on the previous several years. At its 2023 investor day, it emphasized three priorities. In its investment banking and trading business, it wants to maximize client wallet share and grow its financing business. In asset and wealth management, it wants to grow its management fees, including in wealth management and raising third-party capital for its alternatives business. In its new platforms business, it wants to scale and achieve profitability.

Goldman Sachs took some impairments on its investments in the quarter, while investment banking revenue may be bottoming. The company reported net income to common shareholders of $1.07 billion, or $3.08 per diluted share, on $10.9 billion of net revenue. Net revenue declined 9% from the previous year and 11% from the previous quarter, mainly due to declines in trading and merger advisory revenue. Earnings in the quarter were depressed by multiple impairments, including about $500 million for its consumer banking platforms business and another $500 million on real estate investments. These impairments are symptomatic of the state of the economy and the cost of Goldman Sachs stretching beyond its traditional capital markets businesses, but they overall aren't material to the company's total market value that is over $100 billion. We don't anticipate making a material change to our $410 fair value estimate for narrow-moat Goldman Sachs and assess shares are undervalued.

The Federal Reserve has released the results of its annual stress tests. Our key takeaway is that the banking system remains well capitalized, and stress capital buffers, or SCBs, are likely to be declining for nearly half of the banks we cover who participated in the test this year. This will bring some capital relief to some key names under our coverage, including JPMorgan, Bank of America, M&T Bank, Goldman Sachs, and Morgan Stanley. Whether or not management teams will actually lower their internal common equity Tier 1 targets is another story. As they await other potential regulatory changes, we expect most would choose to err on the side of holding more capital rather than less. Even so, we would view these banks as the big winners from this year’s stress tests as results are set to give these banks more buffer space for now.

Goldman Sachs' trading business helped first-quarter results, while the company made progress in winding down portions of its consumer business. Goldman Sachs reported net income to common shareholders of $3.1 billion, or $8.79 per diluted share, on $12.2 billion of net revenue. Investment banking revenue remained subdued, given the uncertainty in the macroeconomy, with the segment's top line down 26% from the previous year (and down about 55% from the company’s 2021 average revenue run rate). While management mentioned seeing “green shoots” for investment banking activity, we find it hard to believe there will be a significant uptick until the question of a recession is resolved and interest rates decline. Trading was a relative bright spot, down just 13% from the previous year but up 46% sequentially. We expect to maintain our $410 fair value estimate for narrow-moat-rated Goldman Sachs and assess the shares as moderately undervalued right now.

Goldman Sachs is refocusing the initiatives it’s been working on the previous several years. At its 2023 investor day, it emphasized three priorities. In its investment banking and trading business, it wants to maximize client wallet share and grow its financing business. In asset and wealth management, it wants to grow its management fees, including in wealth management and raising third-party capital for its alternatives business. In its new platforms business, it wants to scale and achieve profitability. The third priority is a bit more interesting than the first two, as management also mentioned it’s considering “strategic alternatives” for its consumer platforms, which often means restructuring or sale of the business.

Most of the issues that affected Silicon Valley Bank don’t apply to the wealth management firms and investment banks that we cover, so we don’t plan to make material changes to our fair value estimates or Morningstar Economic Moat Ratings for Morgan Stanley, Goldman Sachs, Ameriprise Financial, Raymond James Financial, LPL Financial, Stifel Financial, Evercore Group, or Lazard.

Narrow-moat Goldman Sachs recently had an investor day where it reiterated financial targets, provided a progress report on initiatives since its previous investor day three years ago, and laid out adjusted strategic priorities. Goldman Sachs’ main financial targets for the medium term (3-5 years) remain a 14% to 16% return on equity, a 15% to 17% return on tangible equity, or ROTE, and an expense ratio of around 60%. Our $404 fair value estimate for the firm has a medium-term ROTE slightly below management’s target at 13.5%.

Goldman Sachs reported weak fourth-quarter results for 2022, as net revenue continued its downward trend and expenses remained high. The company reported net income to common shareholders of $1.19 billion, or $3.32 per diluted share, on $10.6 billion of net revenue for the fourth quarter of 2022. Net revenue fell 16% from the previous year with the majority of the decline from investment banking that fell 48% to $1.9 billion and other principal transactions revenue that fell 80% to $369 million. Sequentially, net revenue declined 12% and operating expenses grew 5%, which led to net income falling 60%. The sequential growth in expenses was somewhat surprising, as the third quarter already reflected expenses from recent acquisitions, trading expenses were high while trading revenue was low, management should have been preparing the company for a tougher environment, and historically the company’s compensation ratio in the fourth quarter is low while in 2022 it was the highest compensation ratio quarter. The annualized return on tangible common equity in the fourth quarter was 4.8% compared with the prior nine months of 2022 ROTE of 12.2%. Despite the disappointing fourth-quarter results, 2022 was still the company’s second highest year for net revenue and earnings per share due to acquisitions and lingering benefits from the stimulative monetary and fiscal policies of the previous couple years. As our long-term outlook for narrow-moat Goldman Sachs remains largely the same, we don’t plan on making a material change to our $404 fair value estimate for the firm and assess shares are modestly undervalued.

We are decreasing our fair value estimate for narrow-moat-rated Morgan Stanley to $91 from $96 per share. This implies a forward price/earnings ratio of about 13.5 times and a price/tangible book ratio of 2.3 times. Of the net $5 decrease in our fair value estimate, $2 was from the recent decline in client assets, $2 is from lower investment banking and trading revenue, and $1 is from miscellaneous changes in our model.

COVID-19 boosted revenue in 2020 and 2021 with high trading caused by economic uncertainty, and companies issuing debt and equity to initially bolster capital and then later issuing debt and equity to take advantage of low interest rates and a strong stock market. Net revenue should rest from the unusually strong 2021 level, as economic uncertainty reduces capital issuance, corporate mergers, and asset prices. We forecast Goldman Sachs’ revenue could hover around $50 billion over the next couple years compared with nearly $60 billion in 2021.

While Goldman Sachs’ earnings were down over 40% from a year ago, results were still fairly decent from a historical perspective. The company reported net income to common shareholders of $3 billion, or $8.25 per diluted share, on $12 billion of net revenue. Net revenue fell 12% from a year ago and net income fell 44%, while net revenue sequentially increased 1% and net income increased 6%. 2020 and 2021 net revenue were abnormally high, so we believed that revenue would have reset lower over the 2022 to 2024 period even if the global economy wasn’t on the borderline of a recession. Despite the year-over-year decline, pretax earnings of $3.8 billion were still about 30% higher than the prepandemic, 2017 to 2019 quarterly average. We don’t anticipate making a material change to our $438 fair value estimate for narrow-moat Goldman Sachs and assess shares are undervalued.

Many investment service firms (wealth managers, retail brokerages, custody banks, and asset managers) have material exposure to interest rates. Clients at wealth management firms and retail brokerages typically have 5%-20% of their account balance in cash that the financial institution sweeps into a bank subsidiary. The deposits are then used to make loans or invest in fixed-income securities. They may also earn asset management or distribution fees on client assets in money market funds.

Goldman Sachs has made progress on the strategic plan that it laid out at the beginning of 2020 and set even more ambitious goals in 2022. The company is now targeting a medium-term return on tangible equity of 15% to 17% compared with a previous goal of over 14%. In addition to the ROTE target, management also set an expense ratio goal of about 60% and growth targets for its asset management and consumer banking businesses. While we’re not sure the company will hit all of those goals over the next three years, we forecast the company exceeding a 15% ROTE in the long run after its consumer business has reached a more profitable scale. Goldman Sachs’ trading business also remains a large swing factor, as it requires more capital and tends to have lower operating margins than the other business segments.