I’ll be honest, I voiced concerns over Goldman Sachs Group Inc (NYSE:GS). I wasn’t sure if the bank would be able to meet analyst expectations in the most recent quarter. However, my concerns about volatility having an unfavorable impact on client execution and asset management fees abated this quarter.
Goldman Sachs revenue
Goldman Sachs Group Inc (NYSE:GS) grew its revenue by 30% year-over-year in the second quarter of 2013. This blew my expectations out of the ball park. The growth in revenue was driven by 29% year-over-year growth in its investment banking activities. Goldman Sachs Group Inc (NYSE:GS) reported flat revenue from asset management fees and incentive fees.
Investment banking is growing at really rapid rates.To be publicly listed on a stock exchange while investors are willing to chase higher price-to-earnings multiples is an almost no-brainer for any company that wants to go public. Goldman Sachs reported 55% growth in its equity underwriting activities. Following that, Goldman Sachs Group Inc (NYSE:GS) has been able to grow debt underwriting by 40%.
The growth in lending is driven by the incentive for investors to borrow money prior to interest rates going higher. In classical economic theory, demand goes up in anticipation of higher prices. With the price of interest likely to go up in the future based on the somewhat hawkish stance that the Federal Reserve has had, the gold rush in borrowing will most likely continue.
The institutional client services (client execution in currencies, fixed income, and commodities) grew revenue by 11%. Client execution services (brokerage services) were in high demand as bonds were openly liquidated due to the potential tapering of quantitative easing.
Currency execution was up, because the dollar-yen currency pair experienced headwinds from the Federal Reserve’s change in stance along with the fears of the Bank of Japan’s unwillingness to crank up the amount of asset purchases, which caused double digit percentage swings in the currency pair (which is extremely volatile). The risk in the currency pair abated somewhat as favorable Japanese economic data helped to ease concerns.
Goldman Sachs earnings potential
The earnings growth was largely driven by institutional banking and client execution. The company may be able to experience further revenue growth due to incentive fees from asset management.
A longer-term uptrend in the value of stocks will cause incentive based fees to go up. The growth catalysts don’t end there because the company also invests directly into stocks, so the mark-to-market value of equities will increase, which will contribute to the company’s earnings growth going forward.
The company grew earnings by 101% year-over-year. The growth in earnings came from heavily favorable macroeconomic factors paired with costs that increased at slowing rates. The company’s operating expense increased by 14% in the second quarter, whereas revenue grew by 30%. The net difference in revenue growth and operating expenses had an enormous impact on total earnings. The company reported $927 million in net income for the second quarter of 2012; comparatively, the company reported $1.9 billion in net income for the second quarter of 2013.
The company didn’t provide any guidance in either its earnings release or in the earnings conference call. Because of this, analysts won’t be able to provide accurate growth targets.
Goldman Sachs Group Inc (NYSE:GS) is cautiously optimistic about the future. This is because the company is heavily dependent on the stock market, and stocks can be unpredictable at times. Because of this, the basic assumption is that if stocks go up in value, Goldman Sachs’ earnings will grow that much faster.
Peer comparison
Goldman Sachs Group Inc (NYSE:GS) performance in underwriting was similar to that of JPMorgan Chase & Co. (NYSE:JPM). JPMorgan Chase & Co. (NYSE:JPM) came out and reported a reasonable beat on earnings. However, to be fair, JPMorgan Chase is more of a universal bank, especially after its acquisition of Washington Mutual.
JPMorgan Chase reported 37% revenue growth in its investment banking segment. Unlike Goldman Sachs, JPMorgan Chase & Co. (NYSE:JPM) was actually able to grow revenue in its asset management segment in the most recent quarter. JPMorgan Chase reported growth because its client assets were up by 10% year-over-year.
Comparatively speaking, Goldman Sachs reported a 4% year-over-year growth in assets under management. So the reputational loss that Goldman Sachs suffered through the 2008 market crash has had somewhat of an impact on its ability to attract clientele.
Long-term, I remain optimistic on JPMorgan Chase despite the $410 million settlement that is pending for its recent manipulation of the energy markets. The company’s diversified business portfolio helps to offset the losses from its investment related activities. However, because of the recent issues with the energy markets, earnings growth projections were pulled back, as litigation related expenses are expected to increase. Analysts on a consensus basis are anticipating the company to report flat earnings growth in the second half of 2013.
Wells Fargo & Co (NYSE:WFC) may be under greater pressure than both Goldman Sachs and JPMorgan Chase to grow earnings. Wells Fargo has a smaller set of tools to grow earnings. This is because Wells Fargo & Co (NYSE:WFC) isn’t much of an investment bank, but rather it’s primarily a consumer bank. The company’s primary growth catalysts come from falling loan loss allowances, and growth in cross-sales. Client deposits are up, but the company hasn’t increased the amount of lending by much.
Wells Fargo & Co (NYSE:WFC) reported flat revenue growth for the quarter. This was because the bank reported a 4% decline in net interest income, which was offset by a 4% improvement in non-interest income. The growth in financial services, paired with the company’s growth in lending could give it some upside. But it’s going to be the slowest growing bank of the major five banks on Wall Street (JPMorgan Chase, Citigroup, Bank of America Corp (NYSE:BAC), Wells Fargo, and Goldman Sachs).
Conclusion
I believe there’s a lot of potential in owning Goldman Sachs Group Inc (NYSE:GS). The lack of guidance is a little disturbing but understandable as no analysts predicted the ridiculous beat on earnings in the most recent quarter.
That being the case, investors should look to universal banks or investment banks for higher rates of return. If safety is a priority then Wells Fargo may be for you, as it is more predictable.
The article Goldman Sachs’ Earnings Were a Slam Dunk originally appeared on Fool.com and is written by Alexander Cho.
Alexander Cho has no position in any stocks mentioned. The Motley Fool recommends Goldman Sachs and Wells Fargo. The Motley Fool owns shares of JPMorgan Chase & Co (NYSE:JPM). and Wells Fargo. Alexander is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.