Goldman Sachs (GS 1.78%) saw its stock price tumble 8% on Jan. 18 after the release of fourth-quarter earnings that showed the investment bank had lower earnings and missed analysts' estimates.
For investors, this is an opportune time to buy this stock and add a great company to your portfolio while it's wildly undervalued. Here's why.
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Record revenue, higher expenses
Goldman Sachs' stock price is down about 8% year to date as of Jan. 20, and pretty much all of that dip came after its fourth-quarter earnings report. The bank missed analysts' estimates for the first time in seven quarters, with earnings per share (EPS) at $10.81, below the consensus estimate of $11.77. Earnings were down 11% year over year.
However, revenue was up 8% year over year in the quarter to $12.6 billion, led by investment banking, which saw revenue climb 45% to $3.8 billion. The consumer and wealth management segment was up 19% year over year to $2 billion, while the asset management segment was down 10% to $2.9 billion and the global markets segment was down 7% to $4 billion.
Expenses, which were the culprit for lower earnings, shot up 23% year over year to $7.3 billion. The biggest line item, compensation and benefits, was up 31% year over year to $3.2 billion. Part of it is due to new hires to account for growth and playing catch-up from trying to hold the line in 2020 during the recession. But the bigger issue was wage inflation, as CEO David Solomon explained on the fourth-quarter earnings call.
"Where the component of that is most evident is that there is real wage inflation everywhere in the economy, everywhere," Solomon said.
He added: "Coming out of last year after we went through the compensation process, there were definitely places where I think with hindsight and with the constantly evolving environment of COVID and supply chain changes, the monetary and fiscal policy environment, what that did to savings rates, etc., where there was a real base pressure on what I'd call base compensation and wage levels. And so that's a component of it, for sure."
Operating expenses were higher for the full year, too, up 10% to $31.9 billion, with compensation and benefits representing a 33% increase to $17.7 billion.
But revenue-wise, 2021 was a record year. Goldman Sachs generated $59.3 billion, up 33% from 2020. The investment banking business led the way, with record revenue of $14.9 billion, up 58% from the previous year. The company was No. 1 in mergers and acquisitions (M&A), initial public offerings, and equity underwriting. Asset management and consumer and wealth management also had record revenue, with global markets having its best year in 12 years. Net earnings were also a record, up 137% in 2021 to $21.1 billion.
Opportunity knocks
The recent price swoon presents a good opportunity for investors. Trading at around $356 per share, Goldman Sachs is down over 8% in 2022, and since the beginning of November 2021, it's down about 16%. It is trading at six times earnings, which is extremely low for a company with the earnings power of Goldman Sachs. This is the largest investment bank and one of the largest institutional trading/global markets firms, and it's not going anywhere.
While market conditions might be less favorable for investment banking and advisory in 2022, given the likelihood of interest rate hikes, Solomon said the backlog is higher at the start of 2022 than it was at the start of last year. Plus, he actually thinks M&A activity will be strong again, despite the uncertain market conditions:
We think there's a good tailwind for continued M&A activity. And the uncertainty in the environment interestingly is actually helping that tailwind because it's forcing people to look hard at ways they can strengthen their competitive position. And so I think we have a big reset going on coming out of COVID around supply chains, the way businesses are positioned, and I think that's going to create a significant amount of client activity.
In addition, Goldman Sachs has worked hard to diversify its revenue stream by bulking up its consumer banking/wealth management and asset management businesses. Both of these businesses could benefit in a rising-rate environment.
Goldman Sachs comes into 2022 with strong financials, including a 20% higher book value than a year ago, and an efficiency ratio that's down to 53.8%, from 65% at the end of 2020, even with the expense increases. Its return on equity is 23%, the highest since 2007, and its operating margin is 45.8% -- both good indicators of management effectiveness.
The company might not match the record revenue and earnings it generated in 2021, but it remains well-positioned for continued long-term growth and is wildly undervalued right now.
