Goldman Sachs Trades At A Discount. Here’s Why.

First, there’s the pay. Chairman and Chief Executive Officer David Solomon’s compensation had already been disclosed: His earnings rose 24% to $31 million in a year when net profit fell 24%. The board’s compensation committee, perhaps feeling defensive, highlighted seven factors in support of their decision, including Solomon’s “decisive leadership in recognizing the need to clarify and simplify the firm’s forward strategy.”

But it wasn’t just Solomon who took home a bigger piece of a smaller pie. In aggregate, employees earned $15.5 billion, equivalent to 34% of net revenue, even after severance has been stripped out. While this is not as high a share as in the days prior to the global financial crisis, when it averaged around 46%, it has been ticking up the past two years from a trough of 30%.

One reason could be the firm’s push into alternative asset management, where pay demands are high. The firm is a top five player in the niche, with $295 billion of assets under supervision. Last year it generated over $2 billion in management fees from the business. In spite of weaker realized performance, though, employees did fine. Incentive fees declined to $161 million, yet the firm put aside $407 million in performance-related compensation to be shared among the 800 employees involved.

Pure-play alternative asset management firms like Carlyle Group Inc. have been reassessing how they allocate fees between employees and shareholders, with a trend towards a larger cut of the management fee reserved for shareholders and more of the incentive fee for employees. The objective is to align interests, allowing dealmakers to earn more in boom years and suffer in hard times while satisfying shareholders’ desire for predictability. Goldman has reportedly been doing likewise but to give shareholders the smooth earnings they crave, the firm may have to move fast.

Second, revenue generation is erratic: there are few regular billings in this business. The 10-K provides helpful disclosure on the distribution of Goldman’s daily net trading revenue. Last year, the firm actually lost money on 37 individual days, equivalent to 15% of the trading calendar. That’s on a par with 2022 but before that, you have to go back to 2015 to see as many loss-making days. The difference is that the losses come bigger. In 2015, the biggest daily loss was somewhere between $50 million and $75 million. In 2022, there were three days when the firm lost more than $100 million, and last year there was another.

At the other end of the distribution, Goldman racks up enough profitable days to more than compensate. Last year, it recorded 52 days when it earned more than $100 million, down on the prior year’s 85. That means the firm continues to rely on a few super-profitable days to make its numbers. For shareholders, that creates uncertainty.

Third – not Goldman’s fault, this – it’s tricky to know how much capital a bank like this needs. The firm reports a multitude of capital ratios, calibrated according to both “standardized” and “advanced” measures. Standardized is harsher on credit risk: it demands 35% more capital than advanced. But it doesn’t incorporate operational risk – risks that could stem from a failure of systems or human error, malfeasance or other misconduct – which “advanced” views as being quite big. On the advanced metric, Goldman needs to retain $16.7 billion of capital to cover operational risk, equivalent to 19% of its total risk budget.

And as complex as these rules are, they’re in flux. In July last year, the Federal Reserve proposed new requirements that replace “advanced” with an “expanded risk-based approach.” The good news is that if implemented, they eliminate the use of internal models, making capital requirements more transparent for investors. The bad news: “If our assets and liabilities remain largely consistent with those as of December 2023, our regulatory capital requirements could increase by approximately 25% on a fully phased-in basis.”

Goldman is not alone in trading at a substantially lower price-earnings ratio than the broader S&P 500 Index: All investment banks generate unpredictable profits, juggle tensions between how shareholders and employees divvy up earnings, and endure regulatory whims over how much capital they must retain. But Goldman’s 10-K serves as a helpful reminder.

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This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Marc Rubinstein is a former hedge fund manager. He is author of the weekly finance newsletter Net Interest.

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