2024-01-12 05:29:25 ET
Summary
- Business and Financial Performance: Goldman Sachs relies heavily on trading, facing challenges in retail banking. The institution exhibits notable financial metrics, including substantial revenue and net income growth.
- Strategic Financial Management: Goldman Sachs displays resilience in a competitive financial landscape through effective debt management and robust financial positions.
- Valuation Models: Analysts' estimates propose a 41.4% upside, while a second model, considering market growth and operating income margins, suggests a more conservative 12.7% upside.
- Investment Recommendation: Both valuation models lead to a "Strong buy" rating for Goldman Sachs. Caution is advised due to industry risks, such as limited differentiation and high volatility.
- Industry Challenges: Potential risks include ventures into new markets (e.g., retail banking), industry-wide low growth, and the imperative need for competitive talent acquisition.
Thesis
In this analysis of Goldman Sachs Group, Inc. (GS), I will present two valuation models to elucidate why this company stands out as the premier investment banking giant, poised to deliver excellent returns.
The first model, based on analysts' estimates, projects a fair price per share with a 41.4% upside from the current stock price. However, a contrasting perspective emerges from the second model, suggesting a fair price per share with a 12.7% upside from the current stock price, offering a more conservative view.
Considering these results, I unequivocally recommend Goldman Sachs as a "strong buy." In my assessment, when we broaden our scope to include retail banking giants with significant investment banking operations, the only entity surpassing Goldman Sachs is JPMorgan Chase & Co. (JPM), a comparison I thoroughly explored in my article titled " JPMorgan vs Bank of America vs Wells Fargo ".
Overview
Business
In the markets they operate, Goldman Sachs is very dependent on its trading operations, contributing around 42.76% of revenues, while all other segments don't surpass the 20% mark.
Goldman Sachs earns interest through lending operations, offering the Apple Card, loans, and savings accounts that may be gradually phased out due to challenges in retail banking.
In summary, Goldman Sachs has a significant reliance on trading operations and faces challenges in retail banking, leading to potential changes in its service offerings.
Market
The global investment banking revenue is projected to grow at a CAGR of 1.40% during the same period. These sectors represent the slowest-growing markets within the banking industry, largely attributed to the maturity of the finance industry and minimal differentiation factors.
Turning to other sectors, Worldwide Asset Management is poised for a more respectable growth rate of 4.40% from 2022 to 2027. However, the most dynamic market related to the three banks is Global Wealth Management , projected to achieve an impressive 5.90% revenue growth from 2024 to 2027. This signifies a more robust growth potential in these areas compared to the relatively slower-growing traditional and investment banking segments.
The securities brokerage market in the US is projected to attain a revenue of $160.84 billion in 2024. Comparing this to the 2012 revenue of $120.38 billion, we can observe a growth rate of 2.33.2% in the market's revenue.
Financials
In the financial landscape spanning from 2017 to 2023 TTM, Goldman Sachs has demonstrated noteworthy performance metrics. The institution experienced a revenue growth rate of 6.3% during this period. However, in terms of operating income, Goldman Sachs achieved a growth rate of 2.1%. The net income growth for Goldman Sachs stood at 13.8%, showcasing the institution's ability to generate substantial profits.
When examining margins, Goldman Sachs maintained a 28.93% operating margin and a 17.76% net income margin during the aforementioned period.
The financial structure of Goldman Sachs revealed an accelerated total debt growth rate of 8.5%, primarily fueled by an upswing in short-term debt. In contrast, the institution's cash reserves increased by 19.7% annually, which compensates for that debt growth.
Assessing the ratio of cash to debt load reveals that Goldman Sachs covers 37% of its debt, showcasing a robust financial position in this aspect.
Free cash flow is negative at -$16.92 billion. The average negative free cash flow margin for Goldman Sachs over the period was -10.7%.
Author's Calculations Author's Calculations
In conclusion, Goldman Sachs emerges as a formidable financial institution, showcasing substantial revenue and net income growth. The strategic approach to debt management, coupled with a significant coverage of debt by cash reserves, underlines its resilience in the competitive financial landscape.
Valuation
In this valuation section, I will utilize two distinct residual earnings models for Goldman Sachs.
The process of deriving net operating assets involves deducting cash reserves from total assets, followed by subtracting current liabilities. The latter serves as the operating liabilities in the formula, while all cash reserves are categorized as non-operating assets in this calculation. Therefore, the discrepancy resulting from subtracting cash and marketable securities from total assets will provide us with the operating assets.
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Furthermore, the book value was computed using a margin linked to revenue, achieved by dividing the 2023 TTM book value by the 2023 TTM revenue. This comprehensive approach aims to provide a thorough and accurate assessment of the valuation process.
Operating Assets | 92,164.0 |
Book value | 117,748.0 |
Operating Assets / Revenue | 206.41% |
Book Value / Revenue | 266.97% |
It's worth noting that this is the same table utilized for calculating Weighted Average Cost of Capital [WAAC] in Discounted Cash Flow [DCF] models. However, as this is a Residual Earnings model, the focus will shift to calculating a Capital Asset Pricing Model (CAPM), derived from beta, the risk-free rate, and the average market return.
TABLE OF ASSUMPTIONS | |
(Current data) | |
Equity Value | 106,074.00 |
Debt Value | 646,405.00 |
Cost of Debt | 0.80% |
Tax Rate | 27.84% |
10y Treasury | 3.96% |
Beta | 1.15 |
Market Return | 10.50% |
Cost of Equity | 11.433.2% |
Net Income | 7,834.00 |
Interest | 5,171.79 |
Tax | 2,181.00 |
D&A | 1,906.00 |
Ebitda | 17,092.79 |
D&A Margin | 4.32% |
Interest Expense Margin | 11.73% |
Revenue | 44,106.0 |
In the table below you will find the calculation for the Terminal Value, swell as the CAPM, the WACC would not be used. The beta for Goldman Sachs comes from MarketWatch and the risk free rate is the 10-Y T-Bond, which I got from CNBC when I started to write this article.
Analysts' Estimates
For this initial model focused on Goldman Sachs, I will predominantly rely on analysts' estimates. Regarding revenue, analysts anticipate $46.1 billion for 2023 and $50.67 billion for 2024. As for net income, analysts project an EPS of $23.65 for 2023 and $34.37 for 2024. Multiplying these figures by the number of shares outstanding and then adding the applicable tax rate for Goldman Sachs yields operating incomes of $10.39 billion and $15.1 billion.
To extrapolate revenue and operating income beyond 2024, I will employ a forward revenue growth rate of -5.13%, along with the 3-5 year long-term EPS growth rate of 8.36%.
Revenue | Operating Income | Plus D&A | Plus Interest | |
2023 | $46,100.0 | $10,397.5 | $12,389.71 | $17,795.31 |
2024 | $50,670.0 | $15,110.5 | $17,300.17 | $23,241.64 |
2025 | $48,070.6 | $16,373.7 | $18,451.08 | $24,087.75 |
2026 | $45,604.6 | $17,742.6 | $19,713.35 | $25,060.86 |
2027 | $43,265.1 | $19,225.9 | $21,095.53 | $26,168.72 |
2028 | $41,045.6 | $20,833.2 | $22,606.90 | $27,419.83 |
^Final EBITA^ |
The available estimates paint a less favorable picture for Goldman, suggesting a fair price per share of $547.78, reflecting a 41.4% upside from the current stock price of $387.3. However, projecting ahead, the stock is anticipated to be valued at $1030.28 in 2028, indicating a robust 33.2% annual return throughout the year 2028.
My Estimates
As mentioned earlier, this section will derive its foundation from market revenue growth projections, which I will employ to ensure every segment of Morgan Stanley experiences growth in line with the market prospects for their respective sectors. Additionally, the operating income margin for the period spanning 2023-2028 will be set at the average recorded from 2017 to 2023TTM, which stands at 35.89%.
The most challenging aspect to forecast for Goldman Sachs is trading revenue, given its inherently volatile nature. As illustrated in the graph below from Statista, trading revenue from peer Morgan Stanley has exhibited an annual growth rate of 7.14% from 2009 to 2022. This growth rate will be utilized to project trading revenue for the period 2024-2028. Despite this data originating from Morgan Stanley, it serves as a relevant peer comparison for Goldman Sachs.
Brokers Commission | Trading | Asset Management | Under writing & Investment Banking | Net interest income | |
2022 | 3,880.1 | 19,092.3 | 8,416.5 | 1,041.8 | 7,175.3 |
2023 | 3,988.7 | 20,455.5 | 8,046.2 | 1,056.4 | 7,275.7 |
2024 | 4,100.4 | 21,916.1 | 7,692.2 | 1,071.2 | 7,377.6 |
2025 | 4,215.2 | 23,480.9 | 7,353.7 | 1,086.2 | 7,480.9 |
2026 | 4,333.2 | 25,157.4 | 7,030.1 | 1,101.4 | 7,585.6 |
2027 | 4,454.6 | 26,953.6 | 6,720.8 | 1,116.8 | 7,691.8 |
2028 | 4,579.3 | 28,878.1 | 6,425.1 | 1,132.5 | 7,799.5 |
% of Revenue | 8.69% | 42.76% | 18.85% | 2.33% | 16.07% |
Revenue | Operating Income | Plus D&A | Plus Interest | |
2023 | $40,822.6 | $14,651.2 | $16,415.34 | $21,202.12 |
2024 | $42,157.4 | $15,130.3 | $16,952.09 | $21,895.39 |
2025 | $43,616.9 | $15,654.1 | $17,538.95 | $22,653.38 |
2026 | $45,207.8 | $16,225.1 | $18,178.69 | $23,479.67 |
2027 | $46,937.7 | $16,845.9 | $18,874.29 | $24,378.11 |
2028 | $48,814.5 | $17,519.5 | $19,628.99 | $25,352.88 |
^Final EBITA^ |
This model yields more conservative results compared to the previous one, indicating a fair price set at $436.49, reflecting a 12.7% upside from the current stock price of $387.3. Furthermore, the model suggests that by 2028, the stock should be valued at $805.07, translating into annual returns of 21.6%.
Risks to Thesis
The primary risk associated with both companies lies in the limited differentiation, compounded by the highly volatile nature of the investment banking and trading sectors. Essentially, investors are subject to the management's ability to make sound decisions in acquiring new clients. The paramount asset for both companies is the concentration of talent, as it is the sole means through which they can distinguish themselves.
Another notable risk is that, in a market with little growth, these companies might be inclined to explore new avenues, such as Goldman venturing into retail banking, potentially facing failure due to inadequate risk management. Venturing into uncharted territories requires resources and can lead to accruing debt, as evidenced by Goldman's annual debt increase of 8.5% in the period from 2017 to 2023. It's essential to recognize that, since talent is the most crucial asset for these companies, staying competitive in terms of salaries and bonuses in a low-growth industry guarantees rising costs, which is not a favorable prospect.
In my perspective, Goldman's foray into retail operations is theoretically sound. However, the accelerated partnership with Apple, Inc. ( AAPL ) posed significant risks for comparatively low returns, especially considering the Apple Card's minimal fees, unlimited 2% cash back when using Apple Pay, and earnings shared between Apple and Goldman. On the positive side, initiatives like Marcus, fully managed by Goldman, yield promising returns, with around a 3-4% payout for deposits that could be loaned at 7-13%. I believe Goldman's potential turning point lies in revisiting the retail banking initiative.
Conclusion
In conclusion, the comprehensive evaluation of Goldman Sachs encompasses various aspects, including its business operations, financial performance, and valuation models. The business analysis reveals a heavy reliance on trading operations, which contribute significantly to the company's revenues, while challenges in retail banking pose potential hurdles. Financially, Goldman Sachs demonstrates noteworthy performance metrics, with substantial revenue and net income growth. The strategic management of debt, coupled with robust financial positions, underlines the institution's resilience in a competitive financial landscape.
Moving to the valuation models, the first model, based on analysts' estimates, suggests a fair price per share that indicates a 41.4% upside from the current stock price. However, a more conservative outlook arises from the second model, utilizing market growth projections and average operating income margins. This model proposes a fair price per share with a 12.7% upside from the current stock price, indicating a more favorable perspective.
Despite the positive outlook from both models, which gives Goldman Sachs a "Strong buy" rating, investors should remain cautious due to inherent risks in the industry, such as limited differentiation and high volatility in investment banking and trading. The potential for companies to explore new ventures, like Goldman's foray into retail banking, presents additional risks. Moreover, the industry's low growth and the necessity to stay competitive in talent acquisition pose challenges. In conclusion, while Goldman Sachs exhibits strengths, prudent consideration of associated risks is crucial for a comprehensive investment decision.
For further details see:
Double-Digit Opportunities: Evaluating Goldman Sachs' Appeal