Berkshire Hathaway Inc. (BRK.A, Financial) (BRK.B, Financial) made headlines when the 13-F filing for the first quarter revealed the slashing of The Goldman Sachs Group Inc. (GS, Financial) stake by approximately 84%. In addition, Berkshire cut its stake in JPMorgan Chase & Co. (JPM, Financial) by 3%.
Warren Buffett (Trades, Portfolio) is often considered a guru who has remained bullish on the leading American banks throughout the last couple of decades, most notably during the global financial crisis of 2008. This makes the sale of Goldman Sachs shares even more interesting to investors who are keenly following the Oracle of Omaha to get an idea of business sectors that could deliver stellar returns to investors in the coming years. Contrary to the popular belief that Buffett has lost faith in banks, the sale of Goldman Sachs shares should be considered a strategic asset allocation decision for several reasons.
The guru is still bullish on banks
Even after trimming the Goldman stake from 12 million to just 1.92 million shares, the financial services sector still accounts for the lion’s share of the portfolio with a weight of 37% at the end of the first quarter.
The exposure to this sector, however, has declined consistently from the recent high of over 47% in September 2019, and the sale of Goldman shares is the primary contributor to this development. However, the fact that banks and other financial services companies still account for approximately 37% of Berkshire’s equity portfolio is a clear indication that the conglomerate is bullish on the prospects of this industry.
Goldman Sachs is playing catch up
To get a clear idea as to whether Buffett is no longer optimistic about the prospects for banks, an investor needs to dig deep into the business structure of Goldman Sachs to identify how it operates and earns the bulk of its revenue.
The bank is reliant on its investment banking and global markets businesses. For instance, Goldman Sachs generated approximately 84% of its revenue from these two segments in the first quarter, according to company filings. It’s important to note the success of both divisions is closely tied to the performance of global capital markets. Over the last several years, the bank has tried to diversify its revenue sources to include consumer banking as well. However, loans to corporations account for half of its consumer loan portfolio as well, which gives a clear indication of Goldman’s business strategy.
The bank is in the middle of a transformation story from institutional clients to retail clients, and CEO David Solomon confirmed in many earnings conference calls in 2019 that the bank is finally placing more importance on consumer banking activities. These are positive developments, but its peers have been making these changes since the fallout of the financial crisis. For instance, Morgan Stanley (MS, Financial), under the guidance of James Gorman, who took the helm as the CEO in 2010, was quick to identify the need to diversify into consumer banking business activities that had the potential to deliver higher returns on investment.
Goldman first showed an interest in retail banking products when it launched Marcus, an online-only bank specializing in high-yield savings accounts and unsecured personal loans. One of the more recent moves was the partnership the bank formed with Apple Inc. (AAPL, Financial) to facilitate Apple Card, the credit card launched in 2019. Even with all these measures, Goldman has not been able to grow at a meaningful rate. A comparison of key growth metrics with Bank of America Corp. (BAC, Financial), which is heavily reliant on consumer banking, highlights this issue.
| Growth/profitability metric | Goldman Sachs | Bank of America |
| Revenue growth (5-year CAGR) | (-0.63%) | 0.26% |
| Net income growth (5-year CAGR) | 0.55% | 0.5% |
| Return on equity | 8.02% | 9.07% |
Source: Eikon.
Even though Goldman Sachs has an edge in net income growth, it’s important to remember that Bank of America is a much larger company that generated a net income of over $27 billion in 2019, which was significantly higher that the $8.4 billion generated by Goldman Sachs. This lackluster financial performance was the differentiator between the market performance of these two banks as well.
Goldman Sachs, however, is making steady progress in the consumer banking industry, and in just a few years, Marcus has seen massive success.
Source: Investor presentation.
Over the next couple of years, the bank expects to expand its digital products offering to remain relevant in this new age. Eric Lane, global co-head of the consumer banking division, confirmed the mission of his team during a conference call with analysts last year.
“We aspire to be the leading digital consumer bank. We’re starting with loans, we added savings and cards, and we’re working to build out the balance of the digital products suite, including wealth and checking.”
The growth of the consumer banking segment will not only help the company's earnings, but will also reduce its cost of capital. According to Goldman Sachs Chief Financial Officer Steven Scherr, for every $10 billion in new deposits, the cost of capital will decline by $80 million.
As much as these numbers are promising, Goldman is a few years behind its closest rivals, which include Bank of America, Morgan Stanley and JPMorgan. If the risk of a recession did not materialize for a few years, the bank would have been able to catch up with its peers and be in a better position to weather future economic crises. However, now that the United States is already in a recession, Goldman Sachs could turn out to be one of the hardest-hit banks and the recovery will likely take more time in comparison to competitors.
The investment banking industry is still reeling from the losses seen during the global financial crisis, and the shrinking credit business is at the core of this secular decline.
Source: Harvard Business Review.
This decline in industry revenue will likely persist over the next few years as well, which is not an encouraging sign for Goldman Sachs.
Takeaway
The disposal of Goldman Sachs shares by Berkshire Hathaway has been interpreted by some investors as a sign that Buffett is losing interest in the banking sector. On the contrary, the conglomerate is the largest investor in Bank of America, and in the first quarter, increased its stake in PNC Financial Services Group Inc. (PNC, Financial). A closer look at Goldman’s business structure reveals the bank is still reliant on its investment banking activities that might come under pressure in the coming years. Therefore, the decision to trim the Goldman stake could be a strategic one, not a signal of further troubles for the banking industry.
Disclosure: I do not own any stocks mentioned in this article.
Read more here:
- Bill Miller Says Amazon Could Double in Three Years
- Bill Ackman Is Bullish on Restaurant Brands
- Why Norwegian Cruise Line Is a Good Pick for Value Investors
Not a Premium Member of GuruFocus? Sign up for a free 7-day trial here.
Also check out:
