NEW YORK - An old rule of thumb is that the stock of a bank with a higher return on equity should trade at a greater premium to its book value. Goldman Sachs and Bank of America, which both reported fourth-quarter 2018 earnings on Wednesday, show where this rule of thumb falls short.
Goldman’s net income of $2.3 billion for the period exceeded what analysts had expected. The bank also navigated the tempestuous market better than its peers. Fixed-income trading revenue at the firm now run by David Solomon fell 18 percent in the quarter – much like rivals Citigroup and JPMorgan – but equity traders picked up the slack. Goldman’s headline return on equity of 13.3 percent for the full year was the best in nine years, albeit helped by a one-off tax-related benefit.
Bank of America exceeded expectations too, by the more prosaic means of increasing lending. Its return on equity for the year of 11 percent was lower than Goldman’s, but better than the meager 7.9 percent in 2017. Boss Brian Moynihan has focused on staying out of trouble, cutting costs and lending to relatively low-risk customers. His bank spent just $59 for each $100 of revenue in 2018, compared with an average of $73 over the previous five years.
For now, the market is favoring Moynihan’s staid approach, despite his lower returns. Goldman stock trades at less than 0.9 times its book value, whereas Bank of America is valued at almost 1.1 times. For most of the last decade, the relationship was the other way round. One reason is that Goldman is more volatile – trading made up one-third of revenue in 2018, while at Bank of America it accounted for only half that proportion. Solomon is addressing that by chasing more predictable income streams, including the Marcus retail bank.
Then there’s the enduring shadow of the 1MDB money-laundering scandal in Malaysia, which Goldman has yet to lay to rest. Even if the market is pricing in, say, $5 billion in penalties, it would leave Goldman trading below its $79 billion year-end book value. Citi, the most lowly valued of the big banks with a history of missteps, shows trust takes years to regain. Once that happens, a more predictable kind of excitement could close the valuation gap.
- Goldman Sachs reported earnings applicable to common shareholders of $2.3 billion for the fourth quarter of 2018, equivalent to $6.04 per diluted share. Analysts were expecting $4.49 per share, according to estimates from Refinitiv. Revenue of $8.1 billion was 1 percent lower than a year earlier.
- Goldman’s return on equity for 2018 was 12.7 percent, absent the one-off effects of changes to the U.S. tax regime, compared with 10.8 percent the previous year.
- Bank of America reported $7.3 billion of earnings in the fourth quarter of 2018, equivalent to $0.70 per share. That beat analyst forecasts of $0.60, according to I/B/E/S estimates from Refinitiv.
- Revenue of $22.7 billion compared with analyst estimates of $22.4 billion, and was up 6 percent net of tax effects. Bank of America’s return on common equity of 11 percent for the full year 2018 compared with 7.9 percent in 2017, on the same basis.
- Fixed-income trading revenue in the fourth quarter of 2018 fell 18 percent at Goldman and 15 percent at Bank of America from a year earlier. That followed a pattern set by JPMorgan and Citigroup, which reported 18 percent and 21 percent declines, respectively.
(Editing by Richard Beales and Martin Langfield)
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