Here’s how Goldman Sachs can get a higher valuation

The name Goldman Sachs (GS -4.35% ) 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 equity underwriting.

But the bank also has a lower valuation than many of its peers, largely because so much of its revenue comes from investment banking and trading. Of course, Goldman needs to maintain its dominance in the business, but if Goldman wants a higher valuation, it will have to manage to grow and succeed in other businesses under its umbrella. Here’s why.

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Create more sustainable revenue streams

There’s no denying Goldman’s strength in its investment banking and sales and trading business. But by their very nature, revenues from these businesses can be unreliable and difficult to project. Many investment banking firms can do better in times of volatility. That’s why investment banking boomed in the first two years of the coronavirus pandemic, and profits jumped at Goldman in 2020 and 2021. But those profits will shrink as the world normalizes, although revenues trading in the first quarter of this year increased due to all the market volatility. Yet it is this very dynamic that has led Goldman to receive a lower valuation than some of its major competitors.

Table of GS PE ratios

GS PE ratio data by YCharts.

Goldman is trading at a much lower earnings multiple than Morgan Stanley ( MRS -4.69% ) and JPMorgan Chase (JPM -2.87% )and even trades the same as Citigroup ( VS -2.66% )which has been battered by regulatory issues and years of lagging returns.

The main reason for this is that a large portion of Goldman’s income is related to investment banking, sales and trading. In the first quarter of 2022, nearly 80% of its turnover came from these two divisions. Interestingly, Morgan Stanley, a fairly close comparison, also had this problem, but has spent the last decade building out its wealth and investment divisions, capped by the acquisitions of E*Trade and Eaton Vance in recent years. .

Morgan Stanley revenue distribution.

Image source: Getty Images.

As you can see, Morgan Stanley grew its wealth management revenue by 166% between 2009 and 2021 and its investment management revenue by 500% during that time. Together, the two accounted for 50% of total revenue in 2021. As a result, Morgan Stanley’s stock surged during the pandemic, and the bank set long-term return targets higher than almost all of its banks. competitors.

What Goldman needs to do

Goldman appears to be following a similar path in expanding its wealth and asset management divisions, as well as its consumer banking. Goldman’s consumer banking division includes its consumer digital bank Marcus, which offers deposit accounts and different loan products, including credit cards and personal loans. These three divisions can give the bank more sustainable and predictable revenues.

In 2021, Goldman’s consumer, asset and wealth management divisions accounted for approximately 38% of total revenue. But the company has more aggressive goals it is working towards. In terms of asset and wealth management, Goldman recently set new long-term goals in which it wants to grow its clients’ assets organically by $350 billion per year through 2024, reaching more than 10 billion in client management and other fees in 2024.

In consumer banking and Marcus, Goldman also has big ambitions. Marcus has collected more than $100 billion in deposits since launch and hopes to grow to more than $150 billion in deposits by 2024. Goldman wants to grow Marcus-primarily lending from $12 billion at the end of 2021 to more than 30 billion in 2024, and finally, the bank wants to increase total retail banking revenue from $1.5 billion in 2021 to approximately $4 billion in 2024.

Execution will help with a reassessment

Investment banking and trading will always be Goldman’s bread and butter, and if it loses market share, I’m sure investors won’t be happy. But the ticket to a higher valuation at Morgan Stanley’s level comes through execution in the wealth and asset management segment and its consumer banking division. The goal would be for revenue from these three units to help create greater revenue predictability, represent a higher percentage of total revenue, and also increase total revenue. Given the success Goldman has had so far with Marcus and retail banking, I’m quite confident in management’s ability to execute this.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a high-end advice service Motley Fool. We are heterogeneous! Challenging an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and wealthier.

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