Goldman Sachs (GS 1.60%) took no prisoners in the first quarter of the year, absolutely blowing out all earnings expectations in the firm's best quarter ever. The investment bank reported a profit of $6.8 billion, or $18.60 earnings per share (EPS), on total revenue of $17.7 billion. Analysts on average had only expected Goldman to post EPS of $10.22, so it was truly a massive beat.
Now, Goldman's main business has long been investment banking and trading, which can be extremely volatile. And while the pandemic has resulted in elevated business activity for most investment banks, I think one very valuable thing we just learned about Goldman is that revenue and profit levels are likely to normalize above pre-pandemic levels.
Incumbent business growth
At Goldman's investor day in January 2020, management said that one of the bank's medium-term goals was to grow incumbent business in its investment banking, global markets, and other existing businesses by $2 billion to $3 billion.
At the time, management likely had no idea what was about to happen to the world. Goldman has obviously had no trouble meeting this goal this year, with net revenue of $17.7 billion in the first quarter alone, up more than double from the first quarter of 2020. But this is clearly not a normal run rate. The pandemic boosted all of Goldman's businesses, whether it was the explosion in equity underwriting fees or equities trading or big gains from its private equity book.
However, an analyst noted on Goldman's recent earnings call that market share gains by the bank and the growing industry fee pool in investment banking should support more than a $3 billion higher run rate in investment banking and trading revenue. That makes the $2 billion to $3 billion target set at investor day actually "quite conservative" when you consider the other businesses the bank has been making gains in. Goldman CEO David Solomon responded by saying he felt "extremely confident" in the bank's ability to not only meet the medium-term targets set at investor day, but also exceed them long-term.
Perhaps the other supporting theme in higher normalized revenue at Goldman is commentary regarding special purpose acquisition companies (SPACs). SPACs are shell companies that go public with the specific purpose of merging with a private company and taking it public, typically within two years. Many investment banks benefited immensely from serving as the underwriters to SPACs. There were 248 SPAC listings in 2020 and another 300-plus thus far in 2021, according to SPAC Research. But since this time, new SPAC listings have slowed down, largely due to greater scrutiny from regulators.
First, Solomon said that while he thinks the industry will evolve, he also thinks SPACs are here to stay as a way for companies to access the public markets. Second, while Goldman has done a good job of capturing market share in the SPAC space, SPACs did not make up too much of overall business activity.
Solomon said SPACs made up a single-digit percentage of the mergers and acquisitions (M&A) activity the company participated in during the quarter, and less than 15% of equity capital markets revenue last quarter. With all the SPACs now out there in the market and the incentives for management of these vehicles to make a deal and merge with a company, SPAC activity should continue to benefit Goldman's M&A business.
Sustained higher revenue
Like other investment banks, Goldman has seen huge revenue growth as the pandemic has bolstered investment banking activity. While the revenue and profits seen in the first quarter are bound to normalize and come down, it was valuable to learn that revenue levels should end up higher than they were pre-pandemic. Not to mention all the work that Goldman has done to grow its consumer bank and asset and wealth management division, all of which generate steadier revenue. So, while we don't know exactly what a normal revenue run rate will look like for Goldman yet, it certainly appears to be trending very positively.