As its stock returns to $200, Goldman embodies more stable, less fun Wall St.
In the final carefree months before the first tremors of the subprime debt crisis heralded the world-shaking global financial crisis to come, shares of Goldman Sachs Group Inc. (GS) surpassed $200 for the first time.
It was November 2006, and Goldman was on an historic hot streak as Lloyd Blankfein was enjoying his first full quarter as chief executive. The firm was finishing its most profitable year ever, led Wall Street in most key investment-banking categories and was setting new standards for trading prowess as a credit boom flourished. Upon climbing above $200, Goldman stock had tripled over the prior three-and-a-half years.
The occasion for this reverie is the recent return of Goldman shares above $200, first briefly in April and more decisively this month.
This long, eventful round trip in the stock provides a convenient opportunity to contrast the Goldman of today with that of late 2006 – a time when the capital markets and Wall Street firms were as flush, confident and unrestrained as any time in memory.
In Goldman then versus Goldman now, we can see both the scarring and constricting remedies of the crisis, and the resilience of the Street’s sturdiest firms deep into another, less aggressive financial-market upswing.
The first thing that catches the eye in such a comparison is how broadly similar Goldman’s financial results were in the four quarters preceding its November 2006 run above $200 and over the past 12 months.
In the relevant 2006 period, net income was $9.5 billion on $37.7 billion in net revenue. In the past 12 months, Goldman earned $8.9 billion on $35.8 billion in revenue – for essentially the same profit margin near 25%.
The firm also has about the same market capitalization now versus then at a bit above $90 billion.
Yet the way Goldman achieved those results in 2006 and 2014-15 varies quite a bit, as a result of regulatory demands for more capital and an environment of greater financial discipline.
As of November 2006, Goldman had balance sheet assets of $838 billion, roughly in line with the $865 billion on its books as of March 31 of this year.
In that heady pre-crisis period, those assets were supported by less than $36 billion in equity capital, amounting to a leverage ratio (assets to equity) of 23.4. Today, Goldman’s $865 billion is girded by more than $85 billion in equity capital, for a leverage ratio slightly above 10.
Goldman Sachs 10-year stock chart
In rough terms, this means Goldman is shouldering less than half the gross financial risk it was carrying before the crisis wiped out Lehman Brothers, crippled Bear Stearns and forced Goldman to raise expensive capital in the form of a preferred-stock sale to Warren Buffett’s Berkshire Hathaway Inc. (BRK-A, BRK-B).
When the capital markets were panicking over risks to nearly all of the big Western financial giants, Goldman Sachs and rival Morgan Stanley (MS) were forced to convert to bank holding companies, to become eligible for more direct Federal Reserve liquidity support.
The direct result of the larger capital base is far lower profits generated for each dollar of capital in the firm. Back in ’06, Goldman posted a flashy 33% return on equity, a key performance measure for financial companies. Over the past 12 months, on the same absolute dollar level of profit and assets, Goldman’s ROE was only around 12%.
Investors are still trying to figure out how to forecast a proper long-term ROE for Goldman, and what valuation to place on a firm with a more stable but lower-return business.
After Goldman’s strong first-quarter results, Keefe Bruyette & Woods analyst Brian Kleinhanzl downgraded the stock to the equivalent of a Hold rating with a $210 target price. Even given Goldman’s leading position in a healthy banking and trading environment, Kleinhanzl said it’s hard to envision much upside to the longer-term profit outlook and the shares appeared fairly valued given muted ROE levels.
(That being said, Goldman shares remain a pretty good play on continued heavy corporate deal activity, given its powerful and lucrative merger-advisory practice.)
It’s worth noting that Goldman has not suffered relative to its peers since late 2006. While its stock has trailed the Standard & Poor’s 500 and bank bellwether JP Morgan Chase & Co. (JPM) since then, it has outperformed both Morgan Stanley and the overall bank-stock group.
As analyst Brennan Hawken of UBS says, “Goldman gained considerable market share through the crisis and continues to run a strong franchise, although earnings growth has recently been driven by cost flexibility rather than revenue growth.”
Diminished trading risk appetites
Two other glaring ways Goldman has changed: It has tempered its trading-risk appetite and is paying its people a lot less.
Rules restricting proprietary trading and capital standards that make it more expensive to trade generally have meant that Goldman’s huge fixed income, commodities and currencies business has receded to 24% of total revenue in the past year from 44% in 2006.
And bonuses have become far less lavish. In its 2006 fiscal year, Goldman paid out $16.5 billion to its employees. That was 43.7% of revenue, and amounted to an average of $623,000 per employee (including the top traders and all support staffers). Over the past 12 months, Goldman employees collected $13.1 billion, 36.6% of revenue and an average of $382,000 each. (The employee count has risen to 34,400 from 26,500 over that span.)
Eight-and-a-half years after its stock first surmounted $200 and six years after the crisis, then, Goldman is Wall Street in microcosm: More stable, less risky, firmly entrenched in its core business as financial middleman, less generous to employees and, perhaps, a bit less fun.
This is both how it had to be after the perilous experience of the financial meltdown, and how the public and regulators largely wanted it to be.