Over the last couple of years, initial public offerings (IPOs) plummeted as high interest rates, geopolitical uncertainty, recession concerns, and market volatility created difficult conditions for investment banks that rely on these markets.
However, things are beginning to look up. More companies are exploring IPOs, with Reddit being the new kid on the block following its March 21 debut. Reddit's IPO and others in the pipeline show that the risk appetite for IPO stocks is returning to the market. Here are two investment banks you can buy today to take advantage of the changing trends.
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1. Goldman Sachs
A little over two years ago, demand for newly public companies exploded, and Goldman Sachs (GS 0.78%) enjoyed record profits. According to the consulting firm PwC, 951 companies went public through IPOs, including traditional offerings and offerings through special purpose acquisition companies (SPACs), in 2021.
However, challenging market conditions made it less favorable for companies to go public. The Federal Reserve began aggressively raising its benchmark interest rate in 2022. The federal funds rate went from near zero to 5% in just over a year, resulting in volatility and the first S&P 500 bear market since the pandemic-induced sell-off. In 2023, companies remained cautious about going public; over the two years, there were only 175 IPOs.
Over that period, Goldman Sachs' investment banking revenue fell by 56%. This occurred simultaneously with the bank's move to consolidate its operations, including its struggling consumer banking business.
However, now may be an excellent time to scoop up the investment bank stock. According to Renaissance Capital, "the IPO market's green shoots grew further" in the first quarter, with 30 IPOs raising $7.8 billion. Although the count is similar to last year, the total dollar amount raised more than tripled, thanks to more significant offerings.
Today, Goldman Sachs is priced at 18 times earnings, above its 10-year average. However, investors must remember that the price-to-earnings ratio (P/E) is a backward-looking metric and could be skewed for cyclical businesses like investment banking. When considering this year's projected growth, Goldman Sachs trades at a cheap valuation of 12.3 times forward earnings, making it a solid stock to scoop up if you believe an investment banking revival is coming.
2. Morgan Stanley
Morgan Stanley (MS 0.10%) also relies strongly on investment banking, and over two years, the company saw its revenue from these activities drop by 55%.
The company has navigated the challenging market well, thanks to the strength of its wealth and asset management businesses, which have helped smooth out its earnings volatility. However, the stock price is where it was two years ago, and it could be poised for a breakout if there is a strong pickup in investment banking this year.
Besides IPOs, mergers and acquisitions (M&A) are another significant source of income for investment bankers. Deal volumes dropped in recent years, although not as significantly as IPO volumes. According to PwC, M&A volumes were down by 25% last year as rising interest rates continued to pressure financing.
Signs are positive that M&A is coming back to life. Two major deals were announced last year, including ExxonMobil's $59.5 billion proposed acquisition of Pioneer and Chevron's $53 billion proposed acquisition of Hess. Deals this year include Hewlett Packard Enterprise's $14 billion proposed acquisition of Juniper Networks and BlackRock's $12.5 billion proposed acquisition of Global Infrastructure Partners.
According to Dealogic, the volume of M&A worldwide grew by 30% to $755 billion in the first quarter. Analysts project Morgan Stanley's earnings per share will grow 20% from last year. The stock is reasonably priced at 14.7 times this year's projected earnings, making it another solid investment bank stock to buy as conditions improve.
Two excellent stocks to buy today
Morgan Stanley and Goldman Sachs have ridden out a tough couple of years for the firms. The stocks are back to (or slightly above) their pre-rate-hike prices after both fell 33% over the past couple of years.
The two companies will report earnings in mid-April, and investors will find out how they did in the first quarter. Given what investors have seen from IPOs and M&A in the first quarter, now could be an excellent time to scoop up shares ahead of these announcements.
