Goldman’s recent second-quarter results were absolutely insane. The company rose from the clutches of a government rescue program to lead the entire market to a ferocious four-month rally that has seen many financial stocks triple and quadruple in price.
Needless to say, optimism is abound, with investors beating the drum that the “Ferrari” of Wall Street is an unstoppable force and an essential component of any well designed portfolio.
But not so fast; all that glitters is not gold, or in this case, Goldman.
On the surface, Goldman’s quarterly revenue of $13.8 billion looks amazing, but a closer look reveals that the results may have been a one-time shot due to unusual market volatility.
The company’s fixed income, currency and commodities trading segment produced $6.8 billion in revenue, a home run performance by any standard and an unusually high percentage of total revenue on a historical basis. This group benefitted greatly from unusually wide credit spreads and extreme volatility in the commodity markets, circumstances that have since subsided.
The other big chunk of the company’s revenue came from its Equity trading group, producing $3.18 billion. Stocks were seriously oversold in early March, which led to an amazing 3-month rally that enabled the short-term traders of the world to, as traders say, “crush it.”
So out of Goldman’s $13.8 billion in Q2 revenue, almost $10 billion of it came from trading. Trading that occurred during extreme market conditions that are highly unusual and infrequent.
Trading revenues in general, even at the best firms, are extremely volatile. Trading firms live by the sword and die by the sword. But Goldman isn’t just trading; it’s an investment bank, so what about its other business segments? Can they step up and fill the gap?
Non-Trading Business Segments
The company’s other core business segments performed poorly during the quarter.
Investment banking revenue was down 15% from last year to $1.44 billion. Those numbers don’t look awful on their own, but when considering how many of Goldman’s investment banking rivals have been wiped out (Lehman/Bear Sterns), this segment should be thriving.
Beyond investment banking, the company’s financial advisory division was down 54% to $369 million, not a great showing when individual and institutional investors alike are screaming for more support.
Goldman also has a huge commercial loan portfolio, taking a $700 million write down during the quarter on non-performing assets. If the commercial real estate sector continues to weaken on moribund retail sales, look for big write downs coming down the line.
Analysts and Valuations
The covering analysts, the guys who know this company best, are all over the place with their earnings estimates. The low end of the current-year earnings estimate is $8.75 per share, with the high end coming in at $18. That is a reflection of the high level of uncertainty that remains in the financial sector.
The next-year estimate is pegged at $15.88, an amenic 4% growth projection.
If the market sticks to its current valuation of Goldman at 10.5X current-year earnings, this stock could easily take a haircut of 25% to 50% from its current level if one of its high octane trading divisions blows a tire while doing 145 mph down the freeway.
Take a look at the big jump in GS in the chart below.