Goldman Sachs Q1: I See A Turnaround

Summary:

• Goldman Sachs has reoriented its corporate strategy towards investment banking and sales & trading, leading to a substantial earnings beat in Q1 2024.
• The bank’s focus on high-margin activities and a robust recovery in its investment banking division is likely to result in an upward P/E re-rating.
• The bank’s strong Q1 performance and refocus on its core strengths make it a buy for investors, with potential for continued growth in M&A and capital markets.

Investment Thesis

I believe post Q1 report, Goldman Sachs (NYSE:GS) has reoriented their corporate strategy once again emphasizing investment banking, and sales & trading, the places that the bank built its reputation. This is reflected in the bank’s substantial earnings beat for Q1 2024, with earnings per share coming in at $11.58, and overall net income up by 27.76% YoY. The results were above consensus estimates of $8.56/share. The rise was driven by its rebound in global M&A activity in the same quarter.

While the nation’s fifth-largest bank’s Price-to-Earnings (P/E) ratio on a trailing twelve-month basis stands at 15.78, higher than the sector median of 9.95, the bank’s forward P/E ratio is much more reasonable compared to sector median.

I believe an upward PEG re-rating is likely to happen given its strategic realignment towards high-margin, traditional focus activities and a robust recovery in its investment banking division. This is supported by its successful mitigation of management and leadership issues surrounding Marcus that has weighed on the bank’s performance in the past year (Q1 Earnings Transcript).

With this, I now think Goldman Sachs is a buy for investors. The bank’s refocus on what makes the bank become one of the most prestigious on Wall Street is already paying off. If they can continue to sustain its growth in M&A and capital markets, I think there is plenty of room to run.

Background & Why I Am Doing Follow-Up Coverage?

In November, I wrote a report on how Goldman Sachs was a sell as a result of their poor performance with Marcus.

The financial conglomerate initially ventured into consumer banking with its Marcus platform to diversify its revenue streams beyond its traditional stronghold in investment banking and trading.

However, the risks associated with retail banking and consumer credit were compounded by a competitive market dominated by established players with better consumer banking infrastructures and brand recognition in retail finance. Last year, it was calculated that this move had cost the bank more than $3 billion since December 2020. Ouch.

I believed that one of the biggest issues with Marcus is the lack of focus it put on the bank, and the resulting poor performance. While the bank had already been winding down Marcus when I wrote my last piece on them, the bank has now largely completed that. When I mean winding down, I mean the consumer lending division. This is where I think most of the issues with Marcus emerged.

Management noted on the Q4 call:

We made several important decisions and swiftly executed on them. We exited the Marcus lending business and sold substantially all of our Marcus loan portfolio – Q4 2023 Call.

This is key. The bank is now more than telling, they are showing investors they are once again focused on what makes this banking franchise great. With this, I wanted to follow up on the company. I am far more bullish now.

Q1 Recap

Goldman Sachs kicked off the year with robust Q1 net revenues of $14.2 billion and net earnings of $4.1 billion, equivalent to an earnings per share of $11.58. This reflects an annual return on equity (ROE) of 14.8% and a return on tangible equity (ROTE) of 15.9%.

By the end of 2023 the bank had refocused on investment banking. That helped them earn $2 billion via investment banking fees in Q1 2024, almost 33% higher YoY. They gained from merger consultancies, trading and corporate advisory franchises.

Overall, in the Global Banking and Markets sector, revenues reached $9.7 billion, with an impressive 18% ROE. The advisory segment alone generated $1 billion in revenues to sustain its leadership in announced and completed M&A deals. Equity underwriting revenues climbed to $370 million and debt underwriting to $699 million, fueled by rising industry volumes (Q1 Call).

The bank adopted a leaner operational model as well as deal-making opportunities, which they were well-positioned to leverage​​​​. The US stock market performed well in the early months of 2024, which boosted the bank’s trading revenues and bolstered the case for IPOs, helping the investment banking underwriting division.

Finally, (and quite favorably) there was an uptick in demand for corporate financing and advisory services that contributed to a substantial increase in its investment banking fees, supported by the rebound in global M&A activity, where overall deal volumes surged 30% YoY to over $755 billion.

The bank made the right moves at the right time. While timing markets or trends is usually not smart in business, Goldman’s management was savvy here.

The Fixed Income, Currencies, and Commodities (FICC) segment also showed strong performance, with net revenues of $4.3 billion. This uptick was driven by enhanced results across mortgages, credit, and currencies.

In asset management, while the bank sold off some of their asset management business last year, revenues still rose 18% YoY to $3.8 billion. This increase includes a 7% rise in management and other fees, now at $2.5 billion. The bank’s private banking and lending services business posted revenues of $682 million, although this was affected by the partial sale of the Marcus loan portfolio. Equity and debt investment revenues combined reached $567 million, marked by strong performances in the private equity sector, albeit offset by markdowns in some public positions.

The firm also noted an 11% increase in net interest income to $23.2 billion, attributed to a higher interest rate environment and market forecasts adjusting around the Federal Reserve’s rate strategies.

Goldman Sachs’ CEO, David Solomon, expressed satisfaction with the quarterly performance, noting:

We feel very good about our first quarter results, which reflect the strength of our world-class and interconnected franchises and the earnings power of our firm. This performance was aided by the swift actions we took last year to narrow our strategic focus and play to our core strengths. – Q1 Call

Valuation

Like I mentioned in the investment thesis section, Goldman Sachs’ Non-GAAP P/E (TTM) stands at 15.78, which is much higher than the sector median of 9.95 (this was part of the reason why I rated the bank a sell last time I wrote about them.

Alternatively, its forward P/E Non-GAAP is 11.02, which is also above the sector median of 10.41, but it’s much closer to the sector median. These elevated ratios can initially appear stretched when compared to the broader financial sector, but as this earnings report showed, the bank may have reignited their growth trajectory. With this, paying a slight premium in P/E ratio for a revitalized and stronger business model is, in my opinion, more than worth it.

For example, while we are paying a 5.89% premium through the forward P/E ratio on Goldman Sachs stock, the company’s forward EPS growth (non-GAAP) is expected to be 10.02%, or 230.31% higher than the sector median (10.02% vs. 3.03% growth). A 5.89% premium on the forward P/E for access to 230.31% better growth? I like it.

What I Think The Fair Value Is

While the bank has a slightly higher than sector median forward P/E, I think we have to look at the PEG ratio to see where the bank’s stock could go from here.

The bank’s forward PEG ratio is 1.05, which is lower than the sector median of 1.22. If the bank were to see its forward PEG ratio converge on the sector median of 1.22 -keep in mind their EPS growth is going to be 230% higher than the median, but let’s just assume sector median to be conservative- the banks shares could appreciate by up to 16.2% from where they were at the close on Friday.

As I mentioned, with the challenges related to its Marcus venture now largely resolved, I believe the bank is poised to focus more on its core strengths. I expect this to improve the firm’s prospects for stable and improved future earnings that warrant a higher P/E ratio. The bank’s refocus towards investment banking and trading offers potential for higher returns and better risk management to justify a valuation premium from higher quality of earnings compared to more diversified financial services peers.

Risks To Thesis

Goldman Sachs could have strong upside, but the investment bank does come with risks (as with any thesis).

The biggest elephant in the room is that interest rates remain elevated, and this could cause the investment banking industry to experience another slowdown as we saw in 2022 and early 2023. Higher rates often lead to increased borrowing costs, which can dampen M&A activities as well as initial public offerings (IPOs) and directly affect the bank’s revenue from its advisory and underwriting services needed in its earnings mix.

This also includes the Federal Reserve’s ongoing quantitative tightening, which has increased borrowing costs and could lead to increased consumer and business lending defaults.

In a quote from CEO David Solomon:

I am also mindful that U.S. equity markets are hovering near-record levels at a time when we see — when we continue to see headwinds, including concerns around inflation, the commercial real estate market, and escalating geopolitical tensions around the world. This combination could slow growth… Q1 2024 Earnings Call.

Back on Marcus, there is a risk the bank could see more charge-offs here. Last year, I wrote on how Goldman Sachs was potentially trying to offload their Apple credit card division to American Express, which could lead to potential charge-offs if the bank does go through with this.

Despite these risks, I think that the strength displayed in recent quarterly results reinforces a strong outlook for Goldman Sachs. I believe the firm turned a corner as they went back to their core strengths in investment banking and trading that resulted in impressive Q1 2024 profitability. While macro headwinds remain, I think the bank operating in the area they know best, allows them to do best. You cannot control the world around you, but you can control how you react to it. I think the bank is doing just that.

Bottom Line

Despite the drag from its consumer banking venture, Marcus, Goldman Sachs has managed to start the year on a great footing and cement what I believe is the beginning of a turnaround. I believe that its strong Q1 performance amidst a complex macroeconomic environment underscores the bank’s road to recovery with the support of diverse revenue streams, especially from its high-margin areas like trading and investment banking.

With this, I now believe Goldman Sachs represents a buy (up from a sell last fall). I am incredibly optimistic about their prospects to thrive amid ongoing transformations in the banking industry.

---

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, but may initiate a beneficial Long position through a purchase of the stock, or the purchase of call options or similar derivatives in GS over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Noah Cox (account author) is the Managing partner of Noah’s Arc Capital Management. His views in this article are not necessarily reflective of the firms. Nothing contained in this note is intended as investment advice. It is solely for informational purposes. Invest at your own risk.

Seeking Alpha’s Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

---