Goldman Sachs' Bottom Line Growth Is Key Earnings Driver

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Goldman Sachs shares have been driving higher into 2013 on optimism of a recovering economy, investor inflows into stock markets and expectations that the standalone investment bank is well positioned for an eventual merger and acquisition wave.

While fourth quarter earnings are likely to show Goldman Sachs at the head of the Wall Street pack when it comes to underwriting and trading revenue, the bank still has room to prove to investors it stands apart from peers such as Morgan Stanley.

Notably, Goldman is one of just a handful of banks that's been able to deploy excess capital to reduce its share count in recent years, helping to return its earnings per share to pre-crisis levels, even if other metrics like absolute revenue and return on equity remain well below 2007 levels.

As Goldman focuses on rightsizing its expense and balance sheet, investors should pay attention to capital returns — and share buybacks in particular — as a key part of the bank's share performance in 2013 given uncertainty surrounding trading and investment banking revenue.

"[Goldman] should be able to step up their share repurchases and dividend payments," says Michael Wong, an equities analyst with Morningstar, of his expectation of greater capital returns in 2013. Wong notes that given the cyclicality of Goldman's earnings, the bank generally prefers share repurchases over dividend payouts, which are harder to change in uncertain economic environments.

Currently, Goldman, like its large-cap banking peers, has submitted a capital plan for the Federal Reserve's that will drive any added share repurchases or dividends in 2013.

Already, Goldman has been able to deliver predictable share repurchases that go straight to the bottom line for shareholders.

A Jan. 14 analysis by bank research firm KBW shows that among banks submitting capital plans to the Fed, Goldman is one of just five firms that's been able to consistently reduce its share count through share repurchases in the wake of the crisis. Meanwhile, in 2012, the KBW analysis shows Goldman is one of just seven banks who's total payout ratio of dividends and net repurchases is greater than 50 percent of profits.

"This group of large-cap banks are positioned well for total return investors, in our view, and will likely be added as core holdings to portfolios in 2013," writes KBW analyst Frederick Cannon, in the client research note.

Such expectations contrast sharply with Goldman's main standalone investment banking competitor Morgan Stanley that — like Bank of America/Merrill Lynch — has seen its share count exceed overall asset growth. "[Capital] management will be critical in a slow-growth, highly regulated, banking world... the most successful banks will need to be reducing shares outstanding to achieve strong EPS growth," Cannon adds.

While Wong of Morningstar doesn't expect a blockbuster repurchase or dividend announcement in Goldman's upcoming fourth quarter earnings, especially given a transition underway at the firm's chief financial officer position, the analyst adds that deploying excel capital for capital returns will also help the bank deliver on financial metrics like return on invested capital and return on equity, which have fallen short in recent years.

Capital returns are an important component to Goldman's earnings given investor optimism on the company's shares and uncertainty on whether key earnings drivers such as a debt underwriting boom and trading profits will remain in place in 2013.

Wong of Morningstar expects that as a debt-underwriting boom and trading gains on the bank's fixed income inventory play out, improving equity underwriting and merger and acquisition revenue could provide a revenue offset. However, an investment banking boom isn't a likely first half 2013 scenario, given the economic impact of "fiscal cliff" and "debt ceiling uncertainty."

"We could be in for a relatively flat 2013 revenue year and it could be 2014 where the investment banks start to fire on full cylinders," says Wong, who notes Goldman Sachs shares are fairly valued at prices as of Jan. 14.

Other analysts are optimistic about Goldman's near-term performance.

Morgan Stanley analyst Betsy Graseck is above consensus on Goldman's earnings because of a "less bad trading environment" and the prospect that the bank will be able to mark gains private equity investments it holds.

Still in Goldman's various trading businesses, Graseck expects trading revenue to fall roughly 11 percent quarter-over-quarter, with fixed-income currency and commodity trading proving the biggest decline. Graseck expects a total share buyback authorization of $1.2 billion, or 9.2 million shares and expects compensation expense to end the year at just over 40 percent of overall revenue.

Bernstein Research analyst Brad Hintz sees reason to be optimistic expense cuts will play out in the fourth quarter. Hintz projects total headcount will fall roughly 9 percent, or 3,1000 employees, with the firm's partners falling 13 percent from levels at this time in 2010. A plan to put back office employees into less costly locations could help Goldman impress on the bottom line. "The benefits of the plan have largely been hidden so far," writes Hintz.

Overall, Goldman is expected to earn $3.66 in earnings per share on revenue of $7.8 billion, according to consensus analyst estimates compiled by Bloomberg. For the full-year, Goldman is expected to show $12.20 in earnings per share on revenue of $32.8 billion, however return on equity is expected to come in just above 9 percent, the data show.

By's Antoine Gara

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