We’re positive on the strategic changes that Goldman Sachs (GS) is undergoing, but we wouldn’t be surprised if it takes two years for its efforts to be discernible. The company is in the middle of a front-to-back review of its business that aims to expand revenue on the front end, especially in newer business lines, and optimize expenses and capital of traditional business lines on the back end. The current Goldman narrative reminds us a lot of Morgan Stanley after its Smith Barney merger, where the company is on a trajectory of adding more stable, capital-light revenue streams but the market isn’t giving the company any credit for it. We think that Goldman’s digital banking platform and increasing emphasis on wealth and asset management will increase returns on equity, and that means that shares trading near tangible book value of $198.25 are attractive. We are maintaining our $257 fair value estimate for narrow-moat Goldman Sachs.
Given where we are in the capital markets cycle and Goldman’s investment cycle, it could take a while for the company’s initiatives to clearly show in the bottom line. Management sees 2019 and 2020 as investment years where the expense ratio may not show improvement from current initiatives. Layer on to these investment years that we’re arguably near the apex of this capital markets cycle, and any revenue gains from expanding into new areas could be offset by a cyclical downturn in the company’s traditional businesses. While we see a material probability that the next two years may have flat to down earnings, we are fairly confident that the company will eventually be able to harvest its initiatives into higher returns on equity.
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Michael Wong does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.