Investment brokerage stocks have fallen sharply since the start of 2016 with a majority losing between 20% and 30% of their market value.
However, they now appear to have found a bottom with Goldman Sachs (GS, Financial) leading the marks. Shares of Goldman Sachs dropped from $182 at the end of December last year to about $140 per share last week before rebounding to the current level of about $150.
Goldman Sachs wasn’t the only investment brokerage firm to experience such a sharp decline. TD Ameritrade (AMTD, Financial) dropped from about $35 per share to about $25 per share before rallying back at $28 while Morgan Stanley (MS, Financial) declined from $32 to about $21 but is now back at $24.
On the other hand, Charles Schwab (SCHW, Financial) and E*Trade (ETFC, Financial) fell from $33 per share and $29 per share to trade at $25 and $23 per share, respectively while Interactive Brokers (IBKR, Financial) plunged from about $44 to about $32 per share.
However, all these stocks now appear to have hit a bottom following the recent rebound which also coincides with the current resurgence in the stock market. It is good to note that, while this plunge was primarily part of the overall stock market downtrend witnessed in January and early February, most of these stocks declined multiple times compared to the overall decline in the market.
In addition, not all stocks operating in the brokerage industry experienced the same price movement. For instance, CME Group (CME, Financial) bottomed in late January and has now rallied back to levels it traded at the end of December 2015 while Leucadia National (Trades, Portfolio) (LUK, Financial) bottomed, then topped during the month but is now spiraling downward again.
There are also several small cap players in the investment brokerage industry that appear to have experienced different fortunes to those we have witnessed among the main players over the last four weeks.
However, with Goldman Sachs having hit what appears to be a bottom and now trending upward, perhaps fortunes may be about to change for the rest of the industry. But first, why is Goldman Sachs heading up? Is it a reasonable move or is it just another sucker rally?
Goldman looks fundamentally strong, but growth is slowing
Goldman Sachs' revenue and profits fell in the most recent quarter ended Dec. 31, 2015, by 5.40% and 64.70%. However, the company still continues to enjoy an impressive operating margin at 38% compared to the industry average of about 17%. The company also enjoys a solid bottom line with a net profit margin of 17%.
Goldman Sachs currently has a consensus buy rating from analysts with Oppenheimer having recently raised its price target on the stock from $248 to $259 per share. That price uptick came on Jan. 5, which means it was before the current decline in stock price. About a week ago, it would have been tempting to disregard that price target, but after the recent rebound, it appears as though nothing is impossible.
Are we on the verge of another financial crisis?
Right now there are a number of concerns with regard to the general outlook of the brokerage industry. Companies are trying to find new ways of making money as activity in the market faces a possible slowdown due to the overall decline in the stock market. In fact, there is strong belief among investors that we could be on the verge of a major financial crisis, and even another round of quantitative easing wouldn’t do the trick.
Most traders invest when the market appears to be bullish as they are long-only investors while a few are comfortable with either direction of the market because they can easily take short positions in a downward trending stock.
As such, brokerage companies including those specializing only in derivative securities are looking to add more revenue channels to their pipelines. Some of the services under consideration include money management, merchant banking and a variety of savings accounts.
Since the turn of the year, the market appears to have turned against the financial sector. This turn in fortunes came barely two weeks after the Fed raised interest rates, something for which the market had been yearning for the last 12 months.
A change in sentiment toward the financial sector is likely to affect most financial services stocks including the likes of Goldman Sachs as well as the smallest of players. However, at times like these, investors who have a particular affection for financial sector stocks tend to look into the big players that are often termed as those that are “too large to fail.”
Goldman is certainly one of them, but even more than just being big, the company’s business model is built to withstand harsh economic conditions like the one we are currently witnessing. Barron’s shares the same sentiments after revealing at the end of January that now would be a good time to bet on the big U.S. banks.
Summing it up
Goldman Sachs currently trades at a price-to-earnings ratio of about 12.43x, which compares to the industry average of about 14.42. As such, the stock appears to be cheaply priced compared to its peers on the basis P/E multiple. However, close rival Morgan Stanley appears cheaper at just 8.35x.
Nonetheless, Goldman’s forward P/E ratio for Dec. 31, 2016, earnings of 7.85x suggests that the stock could yet be a good buy at current valuation multiples. In addition, Goldman is currently trading at just 0.88 in P/B ratio, which means it’s valued below its tangible book value.
While financial stocks generally tend to trade at lower levels during financial crises, it doesn’t look as though the U.S. market is in a financial crisis. There is a huge difference between a crisis and a correction, and what we’ve witnessed over the last few months is more likely to be a correction following the bullish uptrend that took place between late 2014 and the larger part of 2015.
The bottom line is that Goldman Sachs is one of the most stable companies in terms of financial position with total cash that’s nearly double the amount of debt on its books in addition to its strong profit margins as discussed earlier. The recent rebound appears to have signaled a potential bottom, and it looks as if the rest of the investment brokerage companies are about to follow the same trend.
Disclosure: I have no position in any stock mentioned.
