Goldman Sachs Group Inc (NYSE:GS) executives are as tuned in to the equity markets as anybody. But I’d bet they’re trying to figure out the market’s reaction to Goldman Sachs earnings on Tuesday morning. One would think GS stock would rise after a monster quarter. Instead, Goldman Sachs stock closed down almost 2% on a green day for the market as a whole.
Indeed, it’s difficult, though not impossible, to see why GS stock has fallen. But in the wake of a bank earnings season in which investors shrugged off similar beats from rivals like Bank of America Corp (NYSE:BAC) and Citigroup Inc (NYSE:C), it’s interesting to wonder what that trading means for the financial sector and the market as a whole.
The Goldman Sachs Earnings Beat
From a headline perspective, Goldman Sachs simply had a monster quarter. EPS came in at $6.95, crushing consensus of $5.67. Revenue grew an impressive 25% year-over-year, almost 15 points better than analysts predicted. Return on equity hit a five-year high at over 15%. Goldman Sachs even raised its dividend to $3.20 annually.
The news still looks solid at the segment level. Investment banking revenue rose 5% YOY. Lower M&A advisory revenues were more than offset by a 27% jump in underwriting.
Institutional Client Services revenues climbed an impressive 31% YOY, in part due to the strength in the long-stagnant fixed-income division. Investment Management fees rose sharply, driving an 18% increase. And Goldman’s Investing & Lending segment benefited from solid performance from privately held securities.
It’s a broad-based beat, then. And it seems to support the bull case for Goldman Sachs stock going forward. As Business Insider pointed out, GS CFO Marty Chavez used the word “diversify” or “diversification” 16 times on the post-earnings conference call.
The company is building out its Marcus consumer banking business, and on the call even admitted to considering acquisitions in that area. Likely incoming CEO David Solomon is known for his collaborative skills, as James Brumley noted last month.
It all goes to the idea that Goldman Sachs is looking to build a safer, broader business going forward. The Q1 results would seem to show a rather large step in the right direction — and would seem to suggest upside, not downside, in GS stock.
Why Did Goldman Sachs Stock Sell Off?
So why did Goldman Sachs earnings lead GS stock downward? One possible culprit, as several news items have noted, is that Chavez said the company wouldn’t buy back stock in the second quarter. But John Carney (formerly of the Wall Street Journal, now at Breitbart) made a more intriguing case.
Carney argued that the beat came from largely unsustainable sources. Indeed, the 34% growth in equity investing came mostly from private equities. Goldman Sachs itself pointed out that the rise was “driven by company-specific events and corporate performance,” while public equity gains actually fell.
In other words, a couple of big bets in the venture capital world came in. That’s not a performance that can be replicated — or one that should be baked into the valuation of GS stock.
Similarly, Carney argues, much of the Institutional Client Services strength came from increased market volatility — and perhaps a few lucky bets there as well. Investors expected that volatility to help Q1 results, though obviously Goldman outperformed.
But the broad point is that Goldman isn’t necessarily a better bank than investors thought looking forward. It simply had a better quarter.
I’m sympathetic to Carney’s argument, but I don’t agree with it entirely. For one, investment banking and investment management both had strong quarters. I-banking backlog is up, and management revenue rose 18%.
Secondly, the performance in fixed income and commodities portends a possible reversion to the mean, which should help profits going forward. Both those businesses have been terrible of late, with trading revenue concerns dogging rivals like Bank of America and JPMorgan Chase & Co. (NYSE:JPM) as well. I’m loath to attribute the monster Goldman Sachs earnings beat solely to one-time factors.
What Does the Reaction Mean for GS Stock and Everyone Else?
As I’ve written recently, I still like JPMorgan and Bank of America best in the financial space. But Goldman Sachs stock has an intriguing case here, trading at a still-modest 1.3x book value and relatively light earnings multiples.
But it’s hard not to see some warning signs in the reactions to the financial sector’s earnings, which kicked off an important season. CNBC’s Jim Cramer argued last week that this was “the most important earnings season for the big banks in years.” Market bulls looking for a catalyst to jump-start the market needed good results to support a resurgence in optimism toward U.S. stocks.
I agreed with Cramer at the time, but clearly that catalyst hasn’t arrived. Even with Wells Fargo & Co (NYSE:WFC) struggling in commercial lending, opening opportunities elsewhere, and a beat from Citigroup as well, investors have shrugged off strong reports. It’s not hard to wonder if a similar lack of enthusiasm might greet the rest of the market in the coming weeks.
There is a lot of good news coming from the financial sector, after all. But the huge run in the market since the U.S. presidential election might have priced in the benefits from tax reform and a strong economic environment. If that’s indeed the case, Goldman Sachs stock might be just one of many that sells off after what looks like a monster earnings report.
As of this writing, Vince Martin has no positions in any securities mentioned.
