Initial public offerings (IPOs) were all the rage two years ago but then came to a grinding halt in 2022, creating challenges for investment banks. Goldman Sachs (GS 1.79%) has seen its stock price fall 28% since its peak in 2021, which was a record year for the investment bank.
Amid a turbulent IPO market and dwindling profits for investment banks, there is a glimmer of hope. During Goldman Sachs' quarterly earnings call, Chief Executive Officer David Solomon signaled that a potential turnaround is approaching. Is it time for investors to seize the opportunity and buy the dip?
The boom and bust of IPO activity in recent years
By all measures, 2021 was a record year for investment bankers. During the year, there were 1,033 new listings. To put that in perspective, that was more listings than the prior three years combined. Companies that went public also raised a record $286 billion, which was 85% more than the previous year.
As a result, investment banks were rolling in dough. Record earnings were commonplace across Wall Street. Goldman Sachs earned nearly $15 billion from its investment banking business, leading all peers in total mergers and acquisitions deals and IPOs. Other investment banks, including JPMorgan Chase (JPM 0.06%) and Morgan Stanley (MS 0.29%), also rode strong capital markets to record investment banking profits.
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Activity came to a screeching halt in 2022 as the tides turned and capital market conditions became much less favorable. One primary culprit of the harsher conditions was inflation and the Federal Reserve's campaign of interest rate increases to bring it down. Since March 2022, the Fed has raised its benchmark interest rates by 525 basis points, the fastest increase in decades.
While higher interest rates have damped inflationary pressures to a degree, they have weighed on dealmaking. Last year, stock market volatility kept companies from going public. With one opportunity to get it right, companies didn't want to leap into the unknown and go public, so IPO activity plummeted.
Investment banking's recovery is underway
PwC, the global consulting firm, said that the IPO markets were "virtually closed" all of last year due to high volatility and falling valuations. Last year was the slowest year on record for IPOs in nearly two decades.
That slowdown had investment banks reeling. Goldman Sachs, which relies heavily on investment banking for revenue, saw fees and its net income slashed in half. Morgan Stanley and JPMorgan Chase had similar declines in investment banking fees, although their more diverse businesses didn't see earnings decline quite as much.
That slowdown has continued this year, although it has moderated as year-over-year comparisons get easier. Investment banking fees at Goldman Sachs have fallen 17% for the year.
However, the third quarter provided investors with reason to be optimistic. Equity underwriting fees at Goldman Sachs grew 26%. Goldman CEO Solomon said that "the IPO market has started to reopen" and that he's "encouraged by the prospects of a wider reopening of capital markets."
Investors will want to monitor how recent IPOs perform
Green shoots are emerging in investment banking activity, but the recovery is still in its early stages. Much of the recovery depends on how newer IPOs perform. IPO markets remain "highly selective," according to the consultant EY. Some of the year's largest IPOs include Arm Holdings, Instacart, and Birkenstock.
If those companies perform well in equity markets, 2024 could see a resurgence in activity. Investors will want to closely monitor deal activity and how the newest IPO stocks perform in the coming months to see if the recovery has legs.
Data source: YCharts
Investors buying investment bank stocks today can get them at a relatively cheap valuation. For example, Goldman Sachs is priced at just 0.87 times its tangible book value, near its lowest valuation during the past decade. Meanwhile, Morgan Stanley and JPMorgan Chase are also near multiyear lows, providing an intriguing entry point for long-term investors if we are indeed in the early stages of a recovery.
