This past year, the XLF has beaten the QQQ by 11%, an impressive performance given Among financial service firms, Goldman Sachs (NYSE: GS) stands out, with a YTD gain of 35%. Share price growth was primarily driven by exceptionally strong Q1 results by GS and the finance industry as a whole. Net revenues of 17.7b, a 51% QoQ growth caused analysts from JPM to Deutsche to upgrade GS EPS estimates. JP Morgan, in particular, upgraded GS’s estimate from $27.45 to $38.83 [1].

Analyst Recommendations

The most recent price target provided by the French investment bank SocGen on the 21st of June raised GS’s target price to $390. Similarly, reports published in June entailed target prices from $390-$452 [2], the average target price is $408.33. The upside given a current price of $357.53, ranges from -12% to 26%, the average upside being 14%.

Adapted from Bloomberg Terminal ANR Dataset, as of 20 June 2021Q1 Performance Analysis — Adapted from Bloomberg Terminal ANR Dataset, as of 20 June 2021
Q1 Performance Analysis

Adapted from 10-Q reportsGoldman showed robust gains in its equity trading and market-making segments in Q1. Goldman’s trading revenues in 2021 has been impressive, with YoY gains of 47% attributed to strength in mortgages, commodities, credit and rates. Equity trading gained 68% YoY driven by market strength. Equity financing at 1.1b, a 65% YoY increase indictive of the increased activity in both the Equity Capital Markets (ECM) and Debt Capital Markets (DCM). Goldman’s FICC intermediation performance was impressive as well, producing a 31% YoY increase. — Adapted from 10-Q reports
Goldman showed robust gains in its equity trading and market-making segments in Q1. Goldman’s trading revenues in 2021 has been impressive, with YoY gains of 47% attributed to strength in mortgages, commodities, credit and rates. Equity trading gained 68% YoY driven by market strength. Equity financing at 1.1b, a 65% YoY increase indictive of the increased activity in both the Equity Capital Markets (ECM) and Debt Capital Markets (DCM). Goldman’s FICC intermediation performance was impressive as well, producing a 31% YoY increase.

Goldman’s investment banking division fared considerably well, with a 73% YoY and a 44% QoQ gain. Equity and Debt Underwriting revenues gained 51% and 315% YoY respectively. Corporate lending revenues dropped 54% YoY to $205m, an indirect result of widening credit spread on hedges.

Asset Management revenues increased 8% YoY, whilst Wealth Management gained 12% YoY.

Consumer Banking

Consumer Banking, under Wealth Management, gained 32% YoY reflecting an increase in net interest income generated from unsecured loans. Goldman’s consumer banking services primarily consists of Marcus by Goldman Sachs and credit cards. Goldman has demonstrated the increased importance of its Consumer Banking unit with the CEO David Solomon quoted saying ‘If something came along that helped us accelerate or advance our strategic growth plans, and we thought it was a good fit strategically ... then we would do it,’ [4]

The firm has launched a Robo-advisor on Marcus, allowing consumers to invest in ETFs and other securities with as little as $1000.

However, it’s important to note the large disparity between the return on average common equity (RoE) between GS’s Consumer and Wealth Management Unit as opposed to its other units. Consumer and Wealth Management had an ROE of 2.7%, as opposed to Global Market’s 14.7% and the average of 11.1%.

Risk Factors

Like other investment banks, Goldman Sachs has 3 main risk factors. Namely, Market conditons, Liquidity, Credit and the General Business Enviroment.

Market Conditions

Goldman Sachs may be adversely affected by conditions in the global financial markets, and broader economic conditions. Goldman’s financial performance is highly dependent on the environment in which it operates. A favourable environment is generally characterized by high GDP growth, liquid and transparent capital markets, low inflation, strong business earnings and business, consumer and investor confidence amongst other factors. Negative market conditions are characterized by declines in economic growth, low levels of confidence, illiquid markets, increased cost of credits, FX and commodity volatility, uncertainty and tariffs amongst other factors.

In addition, Goldman’s asset management and trading units may be affected by declining asset values as many of its businesses have net long positions in debt securities, derivatives, mortgages, equities and other asset classes. Most of GS’ assets are market to market on a daily basis, hence a decline in asset values directly and immediately impacts its earnings, unless they are appropriately hedged. A daily mark to market system means that volatile and illiquid markets increase the difficulty and costs of valuing assets. At times, hedging may not be possible given the illiquid nature of some assets, particularly credit products, leveraged loans, and private equities.

GS receives management fees, and incentive fees based on client portfolio performances, and as such broad-based market declines may reduce the fees earned.

Poor investment performance and preference for products that generate lower fees may reduce revenues from GS’ asset management and wealth management businesses.

Liquidity & Credit

Liquidity is essential to Goldman’s business model, and its business may be impacted by an inability to access the debt capital markets or to offload assets. Illiquid capital markets may arise due to situations that may be out of the bank’s to control such as how an unexpected rate spike choked short-term lending in the repo market in September of 2019.

Liquidity can often be measured by the bid-ask spread. The tighter the spread, the higher the more efficient the liquidity. Widening spreads have in the past, and may in the future affect the firm’s revenue. The firm funds itself ‘on an unsecured basis by issuing long term debt and commercial paper, by raising deposits at (its) bank subsidiaries by issuing hybrid financial instruments and by obtaining loans or lines of credit from commercial or other banking entities.’ [5].

Disruptions to the credit markets make it harder and more expensive to obtain funding for Goldman’s business, which would decrease profitability in its investing lending and market-making units. Moreover, a lack of liquidity in the credit market would depress the number of M&A transactions, hence reducing the demand for advisory and underwriting services.

Credit ratings play a large part in ensuring that Goldman can access capital at low costs. A low credit rating would not only raise borrowing costs and cap the amount that can be borrowed but also trigger clauses under the firm’s collateralized financing contracts. Hence, allowing the counterparty to terminate the contract or force Goldman to post additional collateral. Termination of such contracts would cause the firm to sustain a loss.

As of FY2020, the firm would face a loss of $481m in the case of a one-notch downgrade of Goldman’s credit rating and a $1.39b loss in the case of a two-notch downgrade. The cost of obtaining long-term unsecured funding is directly related to its credit spreads, which is affected indirectly by Goldman’s credit rating.

Credit Rating, and Considerations

According to Bloomberg Intelligence Goldman Sachs is ‘the most exposed of its peers to volatile trading’. Moreover, Goldman has wider spreads as opposed to Morgan Stanley, which is rated a notch higher by Moody’s. In line with the Fed’s new stress-capital-buffer (SCB) requirements, GS had had to raise its capital requirements by 410 bps in 4Q. Although, this may go down if stress test results improve in 2021.

The firm’s stress test results are expected to be released soon, with a passing grade which would pave the way for the firm to return money to shareholders vis a vis dividends and buybacks amongst other ways. Goldman Sachs has 85.2B in CET1 capital, and hence finding the cash to facilitate the aforementioned operations would not be a problem.

The bank is rated A- and BBB+ by Moody’s and the S&P respectfully in regards to long term debt. More information regarding Goldman’s credit rating can be accessed here.

Future Growth Opportunities

The firm identified four key growth areas in upcoming years during the FY2020 investor day. Namely, transaction banking, third party alternatives, digital consumer banking, and wealth management.

Conclusion

Goldman Sachs is a premier investment bank. Though not as attractive as during the March 2020 sell-off, purchasing GS stock would provide a 14% upside in relation to the current average target price. In the upcoming week, the results of the stress test may allow the bank to increase dividends ahead of the 1H2021 presentation and if the firm is once again able to blow analyst expectations out of the water, it will be no surprise if the bank continues its upward trend

[1] Source: JP Morgan Europe Equity Research Report on Goldman Sachs (15 Apr 2021)

[2] Source: Bloomberg Terminal.

[3] Deutsche Bank Report on Goldman Sachs (14 Apr 2021)

[4] Bloomberg/American Banker

[5] Goldman Sachs 10-K FY2020