Dealmaking optimism may not be strong enough to sustain Goldman Sachs rally

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The feast-or-famine nature of Wall Street advisory work means Goldman Sachs’s revenues and profits can be more volatile than those of its Wall Street peers.

Market optimism for this unit has lifted the share price. Shares in the US investment bank have rallied 30 per cent since late October to trade just 10 per cent below the all-time high. Hope that the revival in dealmaking activity seen during the fourth quarter will be sustained in 2024 has produced a similar boost in valuations. Goldman commands a 15 per cent premium to industry leader JPMorgan Chase on a price-to-forward earnings basis.

Never mind that JPMorgan delivered record profits for 2023 while Goldman reported a 24 per cent drop in annual net earnings to $8.5bn, the lowest level in four years.

After a dismal year in which M&A activity sank below $3tn for the first time in a decade, the market is betting the worst is over. Interest rate increases have peaked. The recent stock market rally should encourage more deals and public offerings. Goldman on Tuesday said its M&A backlog had a “really strong replenishment and improvement” in the final quarter of the year.

After a disastrous foray into consumer banking, Goldman has good reason to talk up its deals pipeline. For all its diversification plans, equity and fixed-income trading plus investment banking made up 65 per cent of the $46.2bn in total revenue it pulled in last year. The figure is 42 per cent at Morgan Stanley and 30 per cent at JPMorgan.

Advisory work is highly profitable. Unlike retail banking, advisory does not require much capital. Goldman’s global banking and markets unit delivered a 12.1 per cent return on average common equity last year, compared to 3.2 per cent for its asset and wealth management business. 

But Goldman’s rally also leaves plenty of scope for disappointment. For starters, a return to the 2021 level of record dealmaking is unlikely in 2024. The $12.1bn in net income that analysts expect the company to earn this year will still land well below the $21.6bn it made in 2021.

Bankers are not cheap either. About a third of the revenue Goldman made last year went on salaries, bonuses and benefits. The group’s efficiency ratio — a measure of how much it costs to produce a dollar of revenue — jumped nearly 9 percentage points to 74.6 per cent. Goldman’s bankers will cheer the signs of green shoots. But investors buying in at current valuations may find themselves left with little more than twigs.