The big U.S. banks are much safer than they were before the Great Recession of 2008, and yet they trade at very low valuations today. Banks aren't growing fast enough to lure growth-oriented investors. But at the same time, defensive investors are reluctant to bet on banks because they fear a potential recession. More recently, the flattening yield curve has caused many to abandon bank stocks altogether, almost regardless of value.
Of course, banks stocks have one huge fan: Warren Buffett, who has nearly half of Berkshire Hathaway's (BRK.A -0.28%) (BRK.B -0.68%) equity portfolio in the financial services sector. That's likely because banks today are required to hold more equity capital than they used to. That may limit their growth rates, but it also makes them far, far safer. In addition, banks have been plowing their profits back into share buybacks at low valuations and raising their dividends, two things Buffett loves.
Two of Buffett's big bank holdings are Bank of America (BAC -0.13%) and Goldman Sachs (GS -0.23%). While he loves both, there are some considerable differences between the two. So, which makes the better buy today?
Image source: Getty Images.
Business model
The first distinction between Bank of America and Goldman Sachs is that, while they do have some overlapping businesses, Bank of America is much more focused on consumers and lending, while Goldman Sachs has traditionally been more about institutional services, proprietary trading, and investing.
For instance, Goldman Sachs' biggest segment is its institutional clients services segment, which makes up 39% of revenue. This segment makes markets for trading, and executes complex trades for institutional clients. Goldman also has a significant 20% of revenue coming from investment banking, along with 17% in wealth management.
The remaining 24% is in its investing and lending segment, and within this segment, less than half comes from what you would call "traditional" loans to corporations, real estate, and, just recently, consumers. Goldman is also more active as an investor, with equity investments in companies across private and public markets, real estate, and private equity -- a portfolio totaling $22 billion as of last quarter.
By contrast, Bank of America is more of a "traditional" bank, with more of an emphasis on lending to consumers and businesses. Bank of America's consumer segment made up 42% of the company's revenue last quarter. In contrast to Goldman, Bank of America's global markets segment, which does more of the institutional sales and trading Goldman is known for, only made up 18% of BofA's revenue last quarter.
However, Goldman Sachs is now attempting to get more into consumer banking. Just recently in 2016, it launched a new consumer bank called Marcus, an online-only bank offering high-yield savings accounts and unsecured personal loans. Since then, Goldman has expanded Marcus' product line, most recently with the Apple (AAPL 1.27%) credit card, which is backed by Goldman's underwriting.
Though Marcus is definitely interesting and garners a lot of attention as the hip, tech-savvy consumer bank, it's still tiny compared to the rest of Goldman's business.
Recent results
Goldman's dependence on institutional services and sales and trading tends to make its results more volatile relative to Bank of America, and we saw this happening last quarter.
|
Q2 Operating Metric |
Bank of America |
Goldman Sachs |
|---|---|---|
|
Revenue growth |
2.7% |
(1.8%) |
|
Diluted EPS growth |
17.4% |
(2.8%) |
|
Return on equity |
11.6% |
11.1% |
|
Return on tangible equity |
16.2% |
11.7% |
|
Efficiency ratio |
57.1% |
64.7% |
Data source: Bank of America and Goldman Sachs quarterly filings.
As you can see, Bank of America is currently generating much better metrics -- it's growing faster than Goldman Sachs and making more efficient profits. While Bank of America has been exceptionally managed by CEO Brian Moynihan, its outperformance is likely a result of its simpler business mix relative to Goldman's.
Goldman's market-making and prop trading businesses have been limited by regulation, and there is also a lot of fee pressure in the trading and asset management businesses due to new technology and intense competition. In other words, Goldman's core business is much more challenged by bigger forces, even though Goldman has historically been a leader in that industry. These challenges are what compelled Goldman to develop a consumer bank in the first place.
Valuation
Though Bank of America has the superior operating metrics and a steadier business, the market seems to have priced this in, as Goldman Sachs is quite a bit cheaper than BofA at the moment.
|
Valuation Metrics |
Bank of America |
Goldman Sachs |
|---|---|---|
|
Price-to-earnings ratio |
10.4 |
8.8 |
|
Forward P/E ratio |
9.7 |
8.3 |
|
Price-to-book ratio |
1.11 |
0.95 |
|
Price-to-tangible book ratio |
1.54 |
1.03 |
|
CET1 ratio (2Q 2019) |
11.7% |
13.8% |
Data source: Bank of America and Goldman Sachs quarterly filings.
As you can see, not only is Goldman cheaper on a price-to-earnings and price-to-book basis, but Goldman also has quite a robust balance sheet, with higher CET1 ratios. CET1 ratios show how much equity to risk-weighted assets the company holds, so a higher number means a safer balance sheet, all else being equal.
A matter of choice
Investing in either Bank of America or Goldman depends on what type of investor you are. Bank of America seems to have the safer business mix and steadier results. While it's more expensive relative to Goldman, BofA is still fairly cheap compared to the rest of the market. As you can see, I'm a BofA shareholder myself.
Goldman, on the other hand, is more of a turnaround story, with more risks but higher potential rewards. Its core business is clearly under pressure, and it's trying to develop a next-gen consumer bank from scratch. That's a fairly tall order, carries considerable risk, and will take years to happen. Nevertheless, Goldman Sachs is quite cheap, so if you have faith in Goldman's management to execute on Marcus, the long-term upside could be bigger.
