Goldman Sachs Upped to Neutral - Analyst Blog

We are upgrading our recommendation on Goldman Sachs Group Inc. (GS) to Neutral considering its business model, competitive position in the market, the impact of the recent regulatory reforms and the company's strategic efforts to comply with them.

Goldman's second quarter 2010 earnings per share of $2.75 were significantly ahead of the Zacks Consensus Estimate of $2.10. Earnings surpassed the estimate due to lower operating expenses, partially offset by lower revenues. However, including the impact of $600 million charges related to the U.K. bank payroll tax and $550 million related to the SEC settlement, earnings per share were 78 cents in the reported quarter.

Fundamentally, we expect Goldman Sachs to benefit from its well managed global franchise, strong capital base and leading position in investment banking, capital markets, trading, private equity and asset management business.  

Goldman Sachs topped the industry in globally announced and completed M&A, measured both in terms of deal value and fees, for the first half of 2010, surpassing top rivals such as Credit Suisse Group (CS), Morgan Stanley (MS) and JPMorgan Chase & Co. (JPM). We believe that the key drivers for future growth include opportunities in distressed investments -- where Goldman Sachs is uniquely positioned -- improved investment banking led by M&A and redeployment of excess liquidity.

However, according to the new regulatory reform, banks will be restricted from proprietary trading and investing more than 3% of their capital in private equity or hedge fund investments in the long term. Proprietary trading has been a pivotal source of investment bank profits and the measure is an attempt to minimize the speculation by banks, which might have led to the recent financial crisis.

The new financial regulatory reform will remain a challenge to Goldman's top line for its proprietary trading business and capital investments in private equity or hedge funds. However, we believe the company's proactive measures to strengthen its business model while complying with such regulatory changes is encouraging.

Additionally, following the SEC settlement, we believe that much of the overhang on the stock is removed and along with expectations for an improved operating environment in the upcoming quarters, Goldman is poised to grow in the long term.

Goldman Sachs shares currently carries a Zacks #3 Rank (Hold), implying no clear directional pressure on the stocks over the next one to three months. Considering the positive and the negative arguments for retaining the share in an investors' kitty, we have a long-term Neutral recommendation on Goldman Sachs.