Insights

Is Goldman Sachs Undervalued Right Now?

It’s been a volatile year for the stock market, and the S&P 500 was off to its worst start in over 50 years in the first half of 2022.

However, for long-term investors, these are the times you can make some real money. Stocks have been beaten up across the board, and many top-quality companies have seen their valuations and earnings hit. One company feeling the impact is Goldman Sachs (NYSE: GS).

After a record year last year, the investment bank has seen its earnings and stock price fall. The stock currently trades near its cheapest valuation in years, which raises the question: Is now a good time to buy this value stock?

Goldman was a big winner in 2021

Goldman Sachs provides clients with investment banking services, helping them go public through initial public offerings (IPO), raise debt and equity through capital markets, and complete merger and acquisition (M&A) deals.

The company was a big winner last year when demand for these services skyrocketed. According to FactSet data, over 1,000 companies went public last year and raised $317 billion in the process.  

As a result, Goldman Sachs put up record numbers in 2021, posting $59 billion in revenue representing a two-year growth of 62%. Its investment banking revenue also doubled during this time.

Investment banks’ earnings depend on economic conditions

Unfortunately for Goldman Sachs, investment banking is a highly cyclical business vulnerable to economic conditions. This year has illustrated how extreme the business can be.

According to FactSet, in the first half of 2022, only 92 companies have gone public while raising just $9 billion. This dramatic drop has everything to do with stock market volatility and uncertainty in the broader economy. Inflation is the highest it’s been in 40 years, and the Federal Reserve has aggressively raised interest rates to tamp it down. Add geopolitical uncertainty with Russia’s invasion of Ukraine and the sanctions imposed, and you have a recipe for market volatility.

Image source: FactSet.

This volatility has made companies hesitant to go public until market conditions are more favorable for them. For Goldman Sachs, it’s resulted in a drastic drop in earnings. Through the first six months of this year, Goldman’s revenue is down 25%, and net income is down 45%. Investment banking revenue is down 38%, primarily due to fewer companies going public.  

Image source: Getty Images.

Is the worst is behind it?

Cyclical businesses tend to trade at a low valuation because investors know that the good times don’t last forever. For example, at the end of last year, Goldman Sachs traded at a price-to-earnings ratio (P/E) of 6.5.

This is a cheap valuation, but when you consider the record earnings number and the potential of the business slowing down, the valuation can look justified, which is why I initially thought the stock could be a potential value trap.

Now Goldman Sachs is trading at a P/E ratio of 7.5, but appears to be a better value to me. I think Goldman could be a good value because much of the investment bank’s worst-case scenario has played out. Equity offerings have fallen off a cliff, and the bank’s earnings took a big hit through the first half of this year. The stock is down 22% from its peak price from last year.

Here’s what could help Goldman’s business bounce back

One of the causes of market volatility has been the Federal Reserve’s aggressive interest rate increases. This year, the Fed has increased its benchmark lending rate from near zero to an upper limit of 2.5%.

Effective Federal Funds Rate data by YCharts

Traders are pricing in less aggressive rate increases in the back half of this year. This could be a good thing for market stability and risk assets. In recent weeks, stocks have seen better performance as the relentless selling seems to have eased. If these conditions continue, it could encourage more companies to go public. According to Goldman Sachs, its backlog of deals is robust and above 2021 levels, putting it in an excellent position to capitalize once things improve.

Courtney Carlsen has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Goldman Sachs. The Motley Fool has a disclosure policy.

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