Goldman Sachs Is A Buy Amid Favorable Environment, Attractive Valuation
Contributor since 2014 / 462 Followers
Summary:
- Goldman Sachs’ wealth management and trading units are expected to improve as the stock market climbs and trading volatility generally falls.
- Lower interest rates are likely to boost M&A activity, benefiting Goldman’s M&A fees and overall financial performance.
- Goldman’s trading revenue is expected to rebound in a risk-on, low volatility market environment.
- Strong Q2 results, with significant increases in revenue and earnings, highlight Goldman’s potential for continued growth and profitability.
We Are
With the stock market likely poised to advance and become less volatile going forward, the results of Goldman Sachs’ (NYSE:GS) wealth management and trading units will probably improve going forward. Meanwhile, the investment bank should get a big lift from a meaningful pickup in M&A activity. Finally, the valuation of GS stock is currently quite attractive.
In light of these points, I recommend that investors looking for increased exposure to large financial names buy GS stock.
The Stock Market’s Outlook Is Favorable for Goldman
According to JPMorgan, “Over the past 40 years, the Fed has cut rates 12 times with the S&P 500 within 1% of an all-time highs. The market was higher a year later all 12 times with an average return of around 15%.”
In accordance with this historical data, I can see multiple reasons why U.S. stocks are likely to advance and become significantly less volatile going forward.
First, investors no longer have to worry about “fighting the Fed,” as the central bank is now actively cutting rates. Secondly, rate cuts tend to make bonds and other fixed income instruments less attractive and equities more attractive. And thirdly, although there are some signs that the job market is softening, corporate profits are rising and most economists agree that the U.S. economy is heading for a soft landing. Indeed, the Atlanta Fed is currently predicting that America’s GDP will expand at a real, seasonally adjusted, annualized rate of 2.9% this quarter.
There’s evidence that historically, a risk-on environment with relatively low volatility is best for investment banks trading units. That’s because such an environment produces high activity levels, enabling the banks’ fees to climb. Additionally, lower volatility reduces the likelihood of equity traders making “bad bets.”
Recently, Goldman CEO David Solomon reported that the bank’s trading revenue was on track for a 10% year-over-year decline during the current quarter. But with the U.S. heading for a risk-on, low volatility market environment, particularly after the elections are over. I expect the trading unit’s sales to bounce back in the coming quarters
Similarly, with wealthy investors likely to respond to lower rates by moving from fixed income to more risky assets, the bank’s wealth management unit should also get a sizeable boost in the near-to-medium term. And that business has already been performing well, as its revenue advanced 8% last quarter versus the same period a year earlier.
M&A Will Be Boosted by Lower Rates
Companies that conduct M&A ” are sensitive to high interest rates, which increase the cost of capital.” As a result, declining rates in the U.S. should meaningfully lift M&A activity in the country, causing Goldman’s M&A fees to surge in the coming quarters.
And Solomon on Sept. 9 reported that Goldman’s dealmaking business had already been improving ,although he added that the activity of “buyout firms” had slowed. Lower rates should bring many such firms off the sidelines going forward.
A Lending Boost and Strong Q2 Results
Goldman is looking to double its lending to its “ultra-wealthy private bank clients with account sizes exceeding $10 million,” Reuters reported. The bank believes that it can accomplish this goal because its deposits are rising, the news service explained.
“We were not really focused on lending to our private wealth clients — we did a little bit of it, but it wasn’t a big focus,” Solomon said.
By greatly stepping up its activity in this area, Goldman could meaningfully boost its top and bottom lines.
Speaking of top and bottom lines, the bank reported strong Q2 results, as its top line surged 17% year-over-year, while its earnings per share jumped 183% YOY to $8.73.
Also notably, its investment banking revenue rose 21% YOY to $1.73 billion while its net interest income soared 33% YOY to $2.24 billion and its global banking and markets revenue climbed 14% YOY to $8.18 billion. Clearly, even prior to the Fed’s interest rate cuts, many elements of its business were performing quite well.
Solomon said that the bank’s Q3 revenues would be reduced by a pretax total of about $400 million as it unloads more of its poorly performing consumer business. But with the markets now expecting that hit, the move should not affect GS stock very much.
Goldman’s Valuation Is Attractive
The bank’s forward price-to-earnings ratio is 13.9 times, slightly above the sector average of 12.6 times. However, its forward PEG ratio of 0.74 times is 42% below the sector average of 1.28 times. The PEG ratio is a measure of valuation which takes into account future growth estimates.
Moreover, Goldman’s valuation metrics are significantly lower than those of its large investment bank peer, Morgan Stanley. Morgan Stanley’s (MS) forward adjusted P/E ratio is 14.4, while its forward PEG ratio is 1.18 times. Evercore (EVR), a smaller investment bank, has a forward adjusted P/E ratio of 25.66 and a forward PEG ratio of 0.65, while another smaller investment bank, Stifel (SF), weighs in with a forward adjusted P/E ratio of 15.5 times and a forward PEG ratio of 0.55.
The Risks Facing Goldman Sachs
Despite Solomon’s warning about the $400 million hit to the company’s results due to the unloading of parts of Goldman’s poorly performing consumer business, the move could cause the market to react poorly to the company’s Q3 results.
Additionally, inflation could reignite, causing the Fed to raise rates and causing volatility to return to the markets. In such a scenario, M&A activity would also not recover, and the company’s wealth management business would also not grow in-line with my expectations. Finally, Vice President Kamala Harris could win the election and impose stricter-than-expected regulations on large banks, including Goldman.
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within 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.
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