The name Goldman Sachs (GS 2.02%) has been synonymous with investment banking for decades. The firm is one of the largest investment banks in the world, if not the largest. Goldman has leading market share in several investment banking businesses, including mergers and acquisitions (M&A) and in equity underwriting.
But the bank also has a lower valuation than many of its peers, largely due to the fact that so much of its revenue comes from investment banking and trading. Sure, Goldman must maintain its dominance in the business, but if Goldman wants a higher valuation, it will need to successfully build out and succeed in other businesses under its umbrella. Here's why.
Creating more durable earnings streams
There's no denying Goldman's strength in its investment banking and sales and trading businesses. But by their very nature, revenue in these businesses can be unreliable and difficult to project. Many businesses in investment banking can do better in times of volatility. That's why investment banking boomed during the first two years of the coronavirus pandemic and profits surged at Goldman in 2020 and 2021. But those profits will come down as the world normalizes, although trading revenue in the first quarter of this year surged due to all of the volatility in the markets. Still, it is this very dynamic that has led to Goldman receiving a lower valuation than some of its main competitors.
Goldman trades at a much lower earnings multiple than Morgan Stanley (MS 1.95%) and JPMorgan Chase (JPM 0.49%), and even trades similarly to Citigroup (C 2.45%), which has been beaten down by regulatory issues and years of lagging returns.
The big reason for this is that so much of Goldman's revenue is related to investment banking and sales and trading. In the first quarter of 2022, close to 80% of its revenue came from these two divisions. Interestingly, Morgan Stanley, a pretty close comparison, used to have this issue as well but has spent the last decade building out its wealth and investment divisions, capped off by the acquisitions of E*Trade and Eaton Vance in recent years.
As you can see, Morgan Stanley grew wealth management revenues by 166% between 2009 and 2021 and investment management revenues by 500% during that time. Together, the two made up 50% of total revenue in 2021. As a result, Morgan Stanley's stock has surged during the pandemic and the bank has set higher long-term return targets than just about any of its competitors.
What Goldman must do
Goldman seems to be charting a similar course forward by building out its wealth and asset management divisions, as well as its consumer bank. Goldman's consumer banking division includes its digital consumer bank Marcus, which offers depository accounts and different lending products, including credit cards and personal loans. These three divisions can give the bank more durable and predictable earnings.
In 2021, Goldman's consumer, asset, and wealth management divisions accounted for about 38% of total revenue. But the firm has more aggressive goals it's working toward. In terms of asset and wealth management, Goldman recently set new long-term targets in which it wants to grow client assets organically by $350 billion a year through 2024, achieving over $10 billion in client management and other fees in 2024.
In consumer banking and Marcus, Goldman has big ambitions as well. Marcus has gathered more than $100 billion in deposits since it launched and is hoping to reach more than $150 billion in deposits by 2024. Goldman wants to grow loans mainly from Marcus from $12 billion at the end of 2021 to more than $30 billion in 2024, and finally, the bank wants to boost total consumer banking revenue from $1.5 billion in 2021 to roughly $4 billion in 2024.
Executing will help with a re-rating
Investment banking and trading will always be Goldman's bread and butter, and if it loses market share, I am sure investors will not be pleased. But the ticket to a higher valuation on level with Morgan Stanley comes by executing in the wealth and asset management segment and in its consumer banking division. The goal would be to have revenue from these three units help create more predictability in earnings, make up a higher percentage of total revenue, and also grow total revenue. Given the success Goldman has had so far with Marcus and consumer banking, I feel fairly confident in management's ability to execute on this.