In this article, let's take a look at The Goldman Sachs Group, Inc. (GS), a $81.03 billion market cap company, which is one of the world's leading investment banking and securities companies.
Basel III
We continue to believe Goldman Sachs will remain profitable and will earn above industry average returns on capital. The bank plans to lower its financial leverage to comply with Basel III regulatory capital requirements. As a matter of fact, reallocating capital from lower to higher-return on regulatory capital businesses will be the management´s next actions. Since the 2008 crisis, the bank has cut balance sheet risk by increasing capital so as to absorb losses in case the bank needs it.
Like any other bank, a crisis in the financial system could hurt solvency or liquidity ratios, so Goldman must remain adaptable to adverse scenarios. Cost-cutting policies should improve profitability as well as its business diversification or reduction of some areas such as principal investments and mortgage securitization. This decision may also reduce earnings volatility and improve the balance sheet.
Investment Banking
In the investment banking segment, Goldman differentiates from its peers because of its distribution platform as well as the extensive web of relationships. Further, Goldman has built a good reputation to hire top talent. Moreover, the firm has a solid history of strong growth as well as returns due to advantages, such as technology and risk management.
Dividend Policy
Since 1999, Goldman has a dividend policy showing its commitment to return cash to investors in the form of dividends as it generates healthy cash flow on a regular basis. Although the current dividend yield is not high at 1.2%, it can improve in the future allowing higher shareholder´s returns.
Revenues, Margins and Profitability
Looking at profitability, revenue grew by 16.36%, leading earnings per share to increase in the most recent quarter compared to the same quarter a year ago ($4.57 vs $2.88). During the past fiscal year, the company increased its bottom line by earning $15.47 versus $14.15 in the previous year. This year, Wall Street expects an improvement in earnings ($17.51 versus $15.47).
Finally, let´s compare the best measure of performance for a firm's management: the return on equity. The ROE is useful for comparing the profitability of a company to that of other firms in the same industry.
| Ticker | Company | ROE (%) |
| GS | Goldman Sachs | 13.13 |
| JPM | JPMorgan Chase & Co. | 10.09 |
| RJF | Raymond James Financial Inc. | 12.21 |
| Industry Median | 7.29 |
The company has a current ROE of 13.13% which is higher than the one exhibited by its peers JPMorgan Chase (JPM) and Raymond James (RJF). In general, analysts consider ROE ratios in the 15-20% range as representing attractive levels for investment. It is very important to understand this metric before investing and it is important to look at the trend in ROE over time.
Relative Valuation
In terms of valuation, the stock sells at a trailing P/E of 11.8x, trading at a discount compared to an average of 22.3x for the industry. To use another metric, its price-to-book ratio of 1.12x indicates a discount versus the industry average of 1.42x while the price-to-sales ratio of 2.63x is below the industry average of 3.21x.
As we can see in the next chart, the stock price has an upward trend in the five-year period. If you had invested $10,000 five years ago, today you could have $10,211, which represents a 0.5% compound annual growth rate (CAGR).
Final Comment
As outlined in the article, Goldman has a history of successful margins, as well as the ability to change or adapt its business model. In an era where competitors in the U.S. or in Europe were forced to make restructuring operations, Goldman can take advantage of this and gain market share. Moreover, management and other top-talented people are capable of outperform the competition.
Further, the stock's relative valuation and the return on equity that significantly exceeds the industry average make me feel bullish on this stock.
Hedge fund gurus Joel Greenblatt (Trades, Portfolio) and HOTCHKIS & WILEY bought the stock, while Mario Gabelli (Trades, Portfolio), Ken Fisher (Trades, Portfolio), Charles de Vaulx (Trades, Portfolio), Bill Nygren (Trades, Portfolio), John Rogers (Trades, Portfolio), Richard Pzena (Trades, Portfolio), Dodge & Cox, John Buckingham (Trades, Portfolio), Richard Snow (Trades, Portfolio) and Scott Black (Trades, Portfolio) added this stock to their portfolios in the second quarter of 2014.
Disclosure: Omar Venerio holds no position in any stocks mentioned
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