Goldman Sachs in 2013: Sticking to Its Guns

Investment bank Goldman Sachs (GS 1.93%) joined the Dow Jones Industrial Average (^DJI 0.85%) on Sept. 23, validating its position as the pre-eminent pure-play, integrated investment bank (granted, Morgan Stanley is the only other one left standing). Due to its relatively high share price, Goldman immediately became one of the top three components in the index, along with IBM and Visa (also a new addition to the index).

As the stock gains more prominence and the year winds down, it's worth looking back at the year Goldman had before we look ahead to the year we expect it to have in 2014 (part two, to be published next Thursday).

The numbers

As of Dec. 2. Source: S&P Capital IQ and Motley Fool CAPS.

It's worth noting that on Oct. 4, Goldman welcomed a respected long-term investor as one of its largest common-equity shareholders when the bank delivered 13.1 million shares to Berkshire Hathaway (BRK.B 0.60%) in fulfillment of a modified warrant agreement. The original warrant grant was attached to the $5 billion preferred-share investment Warren Buffett made in September 2008 in order to shore up confidence in the institution.

It's never a bad thing to have a well-informed, long-term investor as one of your main shareholders, although I should point out that the modification of the original warrant terms suggest Buffett was not salivating at the expected returns from Goldman shares.

In terms of the business, Goldman Sachs did well this year -- when it is benchmarked against its peers. As the bank noted in its third-quarter-earnings release, it was "first in worldwide announced and completed mergers and acquisitions for the year-to-date" and "first in worldwide equity and equity-related offerings, common stock offerings and initial public offerings for the year-to-date." Results in fixed income, currencies, and commodities were a little uneven -- revenues fell 47% in the third quarter, a steeper decline than any of its major competitors -- but at this stage, it seems reasonable to attribute this to the natural volatility of the activity.

But those accolades only translated to a 10.4% return on average common shareholders' equity for the first nine months of the year. Had Goldman not reined in the ratio of compensation and benefits to net revenues to 35% in the September quarter -- the ratio for the past nine months is 41% -- the return on equity could have dipped into single digits. Analysts consider Goldman's cost of equity is roughly 10%; it's little wonder CEO Lloyd Blankfein qualified this year's returns as "hardly aspirational," although they did come in ahead of those of its rivals.

Where banks such as Morgan Stanley and UBS have pulled back from the fixed-income business, Goldman is sticking to its guns. That's a legitimate strategy: True, the business isn't so attractive as it once was due to heavier capital requirements, but as competitors withdraw, it creates an opportunity for Goldman to grab market share -- and profits.

More broadly, the investment-banking landscape continues to change dramatically due to regulatory and technological change. Goldman looks well positioned to adapt to the new environment, but it will need to prove that it can do more than just serve its employees -- returns on equity must increase and containing compensation costs will be vital to achieve that.