Wednesday, 19 December 2007

How Good Were Goldman's Results Really?

Yesterday Wall Street's darling Goldman Sachs reported better than expected earnings. The media muppets looked bemused as the stock price fell whilst they lauded praise on the company. From

Goldman scores but shows strains

....As in the previous quarter, the Wall Street firm reported earnings that beat forecasts. Net income at the bank climbed to $3.22 billion, or $7.01 a share, from $3.15 billion, or $6.59 a share a year ago. Analysts were expecting earnings of $6.61 a share. Net revenue also came in slightly ahead of expectations, climbing 14 percent to $10.7 billion.

Last quarter I speculated that Goldman would be lucky to post earnings growth of any kind in 4Q07. They managed 6.4% eps growth, not bad given the operating environment. However whilst the media was busy fawning I couldn't get enthusiastic. The environment for a lot of Goldman's, and by implication the other major brokers, core businesses deteriorated sharply in the fourth quarter however that was disguised in Goldman's case by $800m in asset sales.

Net revenue in Goldman's trading business, by far its biggest division, dropped 16 percent in the past three months, even though it climbed 47 percent from a year ago. The company's investment banking and asset-management divisions also experienced declines from the previous quarter.

"If you look back in the third quarter, the difference is you are getting a slowdown in some of the core businesses," said Brad Hintz, who covers the Wall Street firm for Sanford Bernstein & Co.

Offsetting some of those declines was the sale of assets including an $800 million sale of more than a dozen power plants.

That the broker's core businesses are under pressure shouldn't be surprising given the credit crunch. What I found disturbing about the reporting yesterday was the lack of attention the asset sales got. Since when are asset sales a core business? Analysts usually exclude such items so they can compare like for like.

However most articles on Goldman yesterday didn't even mention it and the ones that did like the one quoted above, barely mentioned it. Excluding asset sales, Goldman's profit would have been 25% lower than the $7.01 eps reported. It would have been more like $5.35. That assumes the asset sales were after tax numbers which we don't know either from the report.

So what's my point? Well I have two really, firstly Goldman's results excluding asset sales was not impressive at all and secondly the outlook for brokers earnings into 2008 is not encouraging as many of their core businesses are under pressure.

Whilst the market seems obsessed with the size of writedowns they should be looking beyond that to the effect that a deteriorating business environment will have on these firms earnings in 2008.