Goldman Sachs’ (NYSE:GS) chief global equity strategist, Peter Oppenheimer, recently stated that the markets have likely come “too far too fast,” warning investors that downside risks still exist. Is it possible that the same can be said about GS stock?
Here’s a look at both sides of this argument.
GS Stock Has Come Too Far Too Fast
Goldman Sachs reported first-quarter earnings April 15. They were a mixed bag with earnings missing analyst expectations, while revenues were better than the consensus estimate.
On the top line, analysts called for revenues of $8.47 billion. The investment bank delivered quarterly sales of $8.74 billion, $270 million higher than expectations. On the bottom, Goldman Sachs’ earnings were $3.11 a share, well below the $3.75 estimate.
While the miss on the bottom line was significant, the results were much lower than a year earlier when it delivered revenue of $8.81 billion, with earnings per share of $5.71. In Q1 2020, revenues and EPS fell by 0.8% and 45.5%, respectively.
Although Goldman Sachs has a total return of -24.3% year-to-date through April 21, GS stock is up nearly 33% from its March 19, 52-week low of $130.85.
Does Goldman Sachs’ business to date in fiscal 2020 deserve a 40% boost, albeit from a level it hasn’t seen since 2013?
A weakened economy hurt the company’s profitability in the first quarter as a result of Covid-19. The investment bank’s provision for credit losses was $937 million, 179% higher than the fourth quarter of 2019.
Most of the $937 million provision for credit losses was due to the oil and gas industry and the expected credit losses in its consumer banking business. I would expect those provisions to be even higher in the second quarter, but that will depend on how quickly the country gets back to work.
The other big negative during the first quarter was its asset management business, which had $1.37 billion in pre-tax losses due in large part from $868 million in losses in its equity and debt investments.
If not for the bank’s trading business, which accounted for almost 60% of its overall revenues and virtually all of its pre-tax earnings, the quarter could have been a lot worse.
CEO David Solomon has been trying to move Goldman Sachs away from trading to more service-oriented businesses, including consumer banking (MARCUS), treasury services for corporations, wealth management, and more corporate lending.
If Q1 2020 is any indication, Solomon’s plan has yet to gain traction.
Goldman Sachs Stock Was Bound to Recover
As I said earlier, GS stock hadn’t traded at $130 since 2013.
While it exhibited some weaknesses in the first quarter, the fact that an old standby (trading) was able to save the day is proof positive Solomon ought to maintain a robust trading business for times like the present, when everything else it throws at the wall fails to stick.
“It really is a favorable business mix for this quarter,” D.A. Davidson & Co. analyst David Konrad said recently.
“This dynamic may shift to a far more difficult environment for capital markets and investment banking and less provision headwinds. It’s a bit of timing for all of these banks.”
During its conference call, Solomon indicated that early in the second quarter, its trading business continues to be “very, very, active.”
Motley Fool contributor Matthew Frankel highlighted why Goldman Sachs’ earnings weren’t nearly as bad as people might think, suggesting that except for a couple of trouble spots which I mentioned earlier, the bank is doing quite well.
I would tend to agree, but it’s important to keep in mind that one quarter’s results do not make a full year. The second quarter is likely to tell us how badly Covid-19 is affecting its overall business.
Is the Rally Justified?
They say the markets look six months ahead. If you believe this fundamental principle of investing, the 40% gains Goldman Sachs’ stock has made over the past three weeks suggests investors believe the bank’s business will start to improve by the fall.
While there’s no doubt the second quarter is going to be much worse than the first, barring some sort of significant setback in the fight against the novel coronavirus (e.g., loosening restrictions too early), the third quarter should be better than the second.
If you own GS stock, I would continue to hold. If you don’t, I would wait for a better entry point. I don’t think it can maintain these levels through the second-quarter earnings release in early August.
Is the rally justified? Probably not. However, a year from now, assuming we’re not still in a recession, I would be shocked if Goldman Sachs wasn’t trading above $200.
Will Ashworth has written about investments full-time since 2008. Publications where he’s appeared include InvestorPlace, The Motley Fool Canada, Investopedia, Kiplinger, and several others in both the U.S. and Canada. He particularly enjoys creating model portfolios that stand the test of time. He lives in Halifax, Nova Scotia. At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.
