Wall Street’s most iconic (and vilified) bank is stronger than ever. The Goldman Sachs Group (NYSE:GS) posted an impressive $6.95 earnings-per-share in Q1 2018, profiting handsomely from a strong economy that is making Goldman’s clientele bullish.
Goldman has long been a stalwart of American finance. The company got into hot water during the financial crisis when it was criticized for taking a massive $10 billion bailout, which the company has tried to downplay. Despite that, in July 2009, only months after paying back the bailout to taxpayers, the bank posted its best quarter ever in its 140-year history. This stunned experts.
Since then, the company has performed generally well, although it has hit some snags with trading and lending. Q1 2018, however, was a strong report for Goldman. It remains to be seen if it can keep it up.
Fueled by a strong economy
Generally speaking, Goldman performs well when its clients do, which means Goldman performs well when the market and economy are strong. Right now, this is the case. Despite only modest GDP growth of 2.3% for the first quarter of 2018, the economy is healthy and the stock market is making record gains.
Goldman had an excellent first quarter of 2018. In fact, Goldman’s Equity Trading group had its best quarter in three years, profiting from the strong (and wild) stock market. Goldman’s revenue from trading equities rose 38% for the quarter to $2.3 billion, outpacing industry expectations by more than 20%. An impressive quarter for equities trading is particularly significant because just last year, in Q2 2017, Goldman suffered its worst ever quarter for trading. The investment bank has clearly used the market’s hot streak and volatility to its benefit. Further, revenue from investing and lending rose by more than 40% to $2.1 billion, chalking up another win for Goldman.
While Goldman’s performance this quarter is a highlight, the positive trend has been ongoing over the last year. The last four quarters all saw impressive earnings reports, all outpacing industry expectations. EPS for Q2 2017 was $3.95 against expectations of $3.36 (+17.6%), for Q3 2017 it was $5.02 against expectations of $4.31 (+16.5%), for Q4 2017 it was $5.68 against expectations of $4.90 (+15.9%), and for this past quarter EPS was $6.95 against expectations of $5.67 (an impressive +22.6%).
Goldman’s financial hot streak is clear and revenue has grown consistently quarter over quarter. If it continues, investors are in for handsome returns.
Now, despite strong recent performance, Goldman has lagged a bit in recent years. Between 2015 and 2016, total revenue dropped from $33.8 billion to $30.6 billion, and it hardly recovered in 2017 when the bank posted revenues of $32.1 billion. Total revenue will likely be a markedly larger number for 2018, however. But, Goldman needs to do what it can to recharge revenue growth.
Further, net income has not been the strongest of late. While net income rose impressively from 2015 to 2016 by 22% from $6.1 billion to $7.4 billion, it dropped by a whopping 42% to $4.3 billion in 2017. However, close examination of the numbers is important and it is clear that Goldman’s net income suffered from an usually high income tax expense last year, that rose by more than $4 billion year-over-year. So, if we look at EBIT growth for 2017, we see that earnings before interest and taxes were reasonable and rose by 8% over the previous year.
Overall, Goldman’s financial health, while not displaying outrageously stellar growth, is strong.
Learning the mistakes of the financial crisis
Has Goldman Sachs learned from the mistakes that led to the financial crisis? Some say yes, some say no. CEO Lloyd C. Blankfein of course gives an empathic “yes!”
We believe that Goldman’s financial success speaks for itself. It has performed very well over the last year and looks to benefit from the increasingly healthy US and global economies.
However, we believe that Goldman stockholders would do even better if the company limited its outrageous compensation packages. After taking government bailout money and then turning its strongest profit in history, Goldman dolled out more than $11 billion in compensation to its workers, including over $22 million for CEO Blankfein alone. While many of America’s largest corporations give out impressive compensation, and money paid to workers is somewhat linked to spending increases in the economy, generally speaking, we see it as financially unwise and wasteful to pay executives such exorbitant sums.
Further, we should caution our readers on management change. While Goldman certainly has many talented bankers ready to take over as chief executive, Blankfein’s impending departure at year’s end will bring an end to his 12-year tenure of leadership. The hope will be that the next leader can continue what worked under Blankfein, and fix the stuff that he was unable (or unwilling) to correct. Fingers crossed.
A note to the politically-minded
We would like to address one important final issue. A moral argument can be made against owning Goldman stock – or part of any investment bank or similar economic institution with past culpability. There were obvious and egregious offenses committed prior to the economic collapse of 2008. Investment bankers were in part at fault for credit default swaps and juicing the housing market. And, there are reasons to believe many of the lessons from the crash have not been heeded by many of America’s largest financial institutions.
However, we believe that, on the whole, the work that Goldman Sachs does is vitally important to the success of many American businesses. They have helped a myriad of companies thrive through entry into the public market, serve customers, and employ hundreds of thousands. Goldman offers a range of important strategic services to companies large and small and helps facilitate liquidity and stability in the world’s stock markets through robust trading. Investment banks certainly could do better, and they should., their place in the American economy in significant, and that makes them potentially attractive to value investors, and rightly so.
Verdict
Regardless of your politics, the Goldman Sachs Group is a safe value-oriented investment. Its services are not likely to go out of spade soon, although you take risk investing in a business very much dependent on the general health of the economy. But, Goldman has shown itself to be resilient. Despite losses in 2008 and the need for a bailout, it pulled a magical white rabbit from its hat in 2009.
The numbers, infrastructure, and history are there to make this a wise investment decision. Answering why now is as simple as looking at the economy – looking at the markets, GDP growth, and trade numbers. Despite bellicose rhetoric from the President of the United States, all looks to likely remain stable in the world of trade, even with minor corrections and adjustments. If the economy continues to perform well, Goldman will as well.
One word of caution: in 2007, everyone was saying the economy was booming and wouldn’t slow down. Housing markets were hot. Lending markets were white hot. And, Goldman and its competing banks benefited handsomely. Then came the Great Recession. In investing in Goldman, we encourage a long-term play so that day-to-day or even quarter-to-quarter changes in the economy do not have as much effect. Goldman might falter, but it will almost certainly pick itself back up. Because, whether good or bad, it truly is “too big to fail.”
Disclosure: I/We own none of the stocks discussed in this article.
This article was co-authored by Clyde Wm. Engle Jr., an investment analyst with Almington Capital.
