3 Risks Goldman Sachs Group, Inc. Must Overcome

The investment-banking world is still risky, and Goldman Sachs knows what it has to do to handle those risks.

Jul 10, 2014 at 4:33PM

Goldman Sachs Tower. Source: Wikimedia Commons.

Goldman Sachs (NYSE:GS) is a leader in the investment-banking world, with popular opinion about the Wall Street giant ranging from admiration for its financial prowess to scorn for its behavior during the financial crisis. Even though Goldman Sachs has done a good job of recovering from the worst of the market meltdown five years ago, its stock price has lagged behind peers Morgan Stanley (NYSE:MS) and JPMorgan Chase (NYSE:JPM), and Goldman Sachs faces many risks that could hurt its future ability to stay strong in the investment-banking world.

GS Total Return Price Chart

Goldman Sachs Total Return Price data. Source: YCharts.

To help you understand those risks, all companies in the stock market are required to identify what they see as their most important risk factors when they file their annual reports with the Securities and Exchange Commission. Let's take a look at three of the biggest risks that Goldman Sachs identified for shareholders to consider to help guide your analysis of its coming earnings results next week.

1. Market behavior affects Goldman Sachs in many of its different businesses.
Perhaps the most obvious risk that Goldman Sachs faces along with Morgan Stanley, JPMorgan Chase, and every other company with investment-banking operations comes from the financial markets. For Goldman Sachs, different market factors affect the bank in different ways, some of which offset each other but some of which amplify overall risk.

For instance, Goldman Sachs often takes positions in securities in order to facilitate client transactions, and although the bank takes steps to hedge the resulting exposure, its hedging efforts don't always match perfectly with the risk Goldman takes on. As a result, drops in asset values can fall through to Goldman's bottom line. Similarly, with Goldman Sachs' asset-management business, revenue based on a percentage of assets under management falls when markets decline. That obviously hasn't been a factor lately, with prices of stocks and bonds generally having moved higher.

Yet some of Goldman's businesses have actually been hurt by recent market conditions. Goldman Sachs has extensive market-making operations, and there, profit depends more on the amount of trading activity in any given market. Lack of volatility has taken away some profit opportunities, yet a big rise in volatility could create illiquidity and cause other problems. Goldman has to walk a fine line in order to balance these countervailing risks and avoid losses.

Source: Goldman Sachs.

2. Expansion into new areas is exposing Goldman to unfamiliar and enhanced risks.
Because of tighter regulation, Goldman Sachs has had to come up with new ways to find profitable business opportunities. In particular, some of the business initiatives that Goldman has pursued include moving into regions of the world where it hasn't traditionally had an extensive presence, including emerging and frontier markets. Those lesser-developed markets don't always have the level of sophistication that Goldman Sachs sees elsewhere, and counterparties there aren't as strong as JPMorgan Chase, Morgan Stanley, and other counterparties that Goldman works more extensively with in domestic and developed international markets.

In addition, Goldman Sachs has taken on exposure to various public-services projects, including taking ownership interests in airports, toll roads, and shipping ports. Those projects can be extremely profitable, but they require Goldman to work directly with government entities and can introduce additional regulatory scrutiny. As Goldman expands in these areas, investors should watch to see if they have a negative impact on Goldman's reputation around the world.

3. Commodities-related businesses are a hot-button issue for regulators.
Goldman Sachs specifically calls out its commodities businesses as having a heightened risk profile. In situations where Goldman directly owns physical commodities, worst-case scenarios involve acts of terrorism or other catastrophic events that could both force the investment bank to renege on supply agreements as well as causing collateral damage and sometimes-uninsurable losses. Regulators have seen these potential risks and have sought to increase regulation of commodities-related activities.

Those regulatory moves have led many investment banks to divest themselves of commodity exposure. JPMorgan Chase sold its materials-trading unit to Mercuria Energy Group a few months ago, and last month, Morgan Stanley agreed to sell its oil storage business to NGL Energy Partners for $200 million. Yet although Goldman Sachs has decided to sell its metals warehousing unit, it remains committed to the commodities business more generally, and that has some investors worried about potential liability in light of past controversies.

When Goldman Sachs issues its quarterly report, keep these three risks in mind. By seeing how Goldman Sachs addresses these risks, you can assess not only how it has done in the past but also what its future will look like.

Goldman Sachs + Apple? This device makes it possible.
Apple recently recruited a secret-development Dream Team to guarantee its newest smart device was kept hidden from the public for as long as possible. But the secret is out... and some early viewers are even claiming its everyday impact could trump the iPod, iPhone, AND the iPad. In fact, ABI Research predicts 485 million of these type of devices will be sold per year. But one small company makes this gadget possible. And its stock price has nearly unlimited room to run for early in-the-know investors. To be one of them, and see Apple's newest smart gizmo, just click here!

Click here to add Goldman Sachs to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.

Dan Caplinger owns warrants on JPMorgan Chase and shares of Apple. The Motley Fool recommends Goldman Sachs and owns shares of JPMorgan Chase. It recommends and owns shares of Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

A Financial Plan on an Index Card

Keeping it simple.

Aug 7, 2015 at 11:26AM

Two years ago, University of Chicago professor Harold Pollack wrote his entire financial plan on an index card.

It blew up. People loved the idea. Financial advice is often intentionally complicated. Obscurity lets advisors charge higher fees. But the most important parts are painfully simple. Here's how Pollack put it:

The card came out of chat I had regarding what I view as the financial industry's basic dilemma: The best investment advice fits on an index card. A commenter asked for the actual index card. Although I was originally speaking in metaphor, I grabbed a pen and one of my daughter's note cards, scribbled this out in maybe three minutes, snapped a picture with my iPhone, and the rest was history.

More advisors and investors caught onto the idea and started writing their own financial plans on a single index card.

I love the exercise, because it makes you think about what's important and forces you to be succinct.

So, here's my index-card financial plan:


Everything else is details. 

Something big just happened

I don't know about you, but I always pay attention when one of the best growth investors in the world gives me a stock tip. Motley Fool co-founder David Gardner (whose growth-stock newsletter was rated #1 in the world by The Wall Street Journal)* and his brother, Motley Fool CEO Tom Gardner, just revealed two brand new stock recommendations moments ago. Together, they've tripled the stock market's return over 12+ years. And while timing isn't everything, the history of Tom and David's stock picks shows that it pays to get in early on their ideas.

Click here to be among the first people to hear about David and Tom's newest stock recommendations.

*"Look Who's on Top Now" appeared in The Wall Street Journal which references Hulbert's rankings of the best performing stock picking newsletters over a 5-year period from 2008-2013.

Compare Brokers