Despite struggles with its consumer banking segment, Goldman Sachs (GS -1.70%) has continued to dominate its core businesses of investment banking and sales and trading. It's gained market share and hit return targets it laid out at its investor day in 2020. The stock is up close to 55% over the past three years.
But despite earnings growth and share-price appreciation, Goldman hasn't really seen its valuation change in terms of its earnings multiple or price-to-tangible-book-value ratio, while rival Morgan Stanley (MS -2.98%) has moved ahead of Goldman in terms of valuation.
At Goldman's recent investor day, Chief Financial Officer John Waldron told investors that the bank's asset and wealth management (AWM) business may "be the largest value unlock for the firm over the next several years." Here's how.
More durable earnings
When Goldman launched its consumer banking efforts roughly six years ago, the goal was to create a more durable stream of earnings that would be more reliable and therefore garner a higher valuation from the market. Investment banking and sales and trading can be extraordinarily profitable businesses, but they are also cyclical and hard to predict, as evidenced by the last few years.
GS Net Income (TTM) data by YCharts
This is why lots of large Wall Street banks are turning to AWM. Asset and wealth management generates more consistent revenue and the bonus is that it is a capital-light business, meaning banks don't have to support a lot of it with their balance sheet. With large bank regulatory capital requirements continuing to rise, this makes AWM more attractive these days.
Transitioning AWM
Make no mistake, Goldman has a large AWM segment. It's the fifth-largest asset manager in the world and at the end of 2022 had more than $2.5 trillion of assets under supervision. But again, the goal for these large banks with high regulatory requirements is to run a capital-light AWM business that generates lots of fees.
Goldman, however, has on-balance-sheet alternative investments of $59 billion, which consume capital and make the segment more volatile because they move up and down with market conditions. Goldman's AWM revenue in 2022 made up roughly 28% of total revenue, but it declined 39% year over year.
Meanwhile, at Morgan Stanley, wealth and investment management revenue made up about 55% of total revenue. Wealth management revenue, which is much higher than investment management revenue, actually grew 1%.
Goldman is planning to bring down its on-balance-sheet investments from $59 billion to below $35 billion in the medium term, which typically means over a three- to five-year period. This should also help lower the bank's regulatory capital burden. The company also plans to further focus on a third-party funding model for AWM and continue to increase management fees, which it has had success in doing. AWM management fees have increased at a 13% compound annual growth rate since 2019 and risen from $6 billion to $8.8 billion, well on their way to Goldman's $10 billion goal by 2024.
There is a clear path
The good news for investors is that I think there is a much clearer path toward unlocking value with AWM than if Goldman had pressed on with its consumer banking initiatives, which have racked up billions in losses since 2020.
Goldman needs to reduce its on-balance-sheet alternative investments and continue to grow assets under supervision and management fees, which it has done a pretty good job with in recent years.
