Goldman Sachs released its 10-k (annual report) slightly more than two weeks ago. Given the changes in the environment in which Goldman operates (regulatory, competition etc.), I thought it would be useful to check what changed versus the 2013 10-k form. For this purpose, I used a technique called textual comparison—I compared the two 10-k’s to see what changed. In many cases, those changes are mandated by the company’s legal advisors that require it to make certain disclosures. As such, we can glean a few insights from observing those changes over time. It is advisable for every investor to use this technique on filings that his/her holdings makes. With that, let the fun begin.
The red text represent pieces of texts that were added on the 2014 filing and did not appear on the 2013 filing. First, it seems like the competition from smaller institutions has intensified, which made Goldman make an extra disclosure. In addition, there is an extra disclosure about the notorious Dodd-Frank regulation and it’s impact on Goldman’s ability to compete with non-U.S.-based competitors.
Regulation & G-SIBs
On this section the news are broadly good—many rules that were still in legislation process were finalised during 2014 so now Goldman knows the nature of the beast that it has to deal with and if history is any guide, Goldman should be able to adjust itself and find a way to achieve decent (15% ROE) profitability under the new framework. Less uncertainty is a good thing for business so even though some of these rules might make life a bit more difficult for Goldman, the fact that some uncertainty was removed is good news in my opinion.
If G-SIB sounds to you like a curse, then you are right because it is. Unfortunately, Goldman is among the chosen-8 Global Systemically Important Banks. While this title seems lucrative, it actually means that extra capital requirement—that translates into potentially lower profitability—will be imposed on Goldman. While this news seems negative, this was in the cards for a long time and at least now things were made clear.
There is a ton of other new sections that relate to derivatives, swaps, trading and other new regulations but this is out of the scope of this post so I’ll leave my diligent readers to do some work on their own here.
Buybacks & capital allocation
One thing that I really like about Goldman is the fact that in recent years it repurchased it’s stock—a lot of it—on the cheap. March’s 2015 stress-test results are already out and Goldman did pretty well so I expect the Fed to approve Goldman’s capital plan for the upcoming year, which will probably include increased buybacks. Goldman bought back about 20% of it’s shares since early 2011 at very attractive prices. This buyback, in turn, increases the share of the pie that each stock represents and when done at attractive prices, as Goldman has been doing in the past few years, it increases the intrinsic value behind every share.
As we can see below, Goldman keeps on adjusting itself by shrinking the balance sheet and pulling capital out of low-return activities.
Most good businesses are really good at operating their business but usually show mediocre performance when it comes to capital allocation. One of the reasons why I love Goldman is that this company is great both at it’s operations as it is the golden standard in investment banking AND at capital allocation. Not many CEOs are willing to shrink their balance sheets and simply return capital to shareholders. Usually, due to the structure of the typical CEO’s compensation plan, most CEOs want to keep on the expanding their empire and even if they will take capital from one department that fails to produce satisfactory returns, they will usually plow this money into new ventures and will rarely use it to buy back stock on the cheap as Goldman does. Anyway, I’m getting sidetracked here so let’s go back to the main topic.
No more increasing conflicts of interest
Pay attention to what was deleted from this part of the section that discusses risks, they removed a part that read “Conflicts of interest are increasing”
This can’t be bad news!
Country and industry exposure
Extra two paragraphs about country and industry exposure were added to the report, these sections are very informative:
And finally, we all got one year older…
While most of these changes seem to be for the bad, one has to remember that these changes usually come at the advise of corporate lawyers who want to be on the safe side in terms of disclosure. Lawyers have a tendency to make things look more complicated than they are so it’s important not to get too carried away. I think the over the next few years there are plenty of catalysts for Goldman:
- Goldman built a lot of operating leverage into the business, which is now ran at low utilisation. When things get better in FICC for instance, I think that everybody will be surprised by how well Goldman positioned itself.
- Less regulatory uncertainty will serve Goldman well. Once the rules of the game are clear, and they became a lot clearer this year, Goldman will be able to be more aggressive in chasing opportunities.
- Goldman’s ROA and ROE are well below it’s long-term average and while I don’t think that it will be easy to get to 20% ROE again, 15% is definitely within reach. On the current equity base, 15% ROE means increase of about 40% in the earning power. Should Goldman earn 15% ROE again it will earn close to $12bn a year. A company that consistently grows it’s book value year in and year out, earns 15% ROE and enjoys a competitive advantage should trade at a PE of at least 13 and this implies a stock price that is almost twice today’s stock price.