Goldman’s Results Foretell Trouble for Morgan Stanley

Goldman SachsGoldman Sachs (GS) reported a wider-than-expected fiscal fourth quarter loss as virtually no segment of its business was unscathed by the credit crisis. The company reported a quarterly loss of $2.12 billion or $4.97 per share, the first quarterly loss in the company’s history as a public corporation and the first loss overall since 1929. Analysts had expected Goldman to lose in the neighborhood of $3.73 per share. Revenue dropped 37% in underwriting, 48% in investment banking and 54% in financial advisory services. It comes as no surprise that there is simply less opportunity for Goldman Sachs in this environment yet, as Chief Executive Lloyd Blankfein noted: “While our quarterly performance obviously didn’t meet our expectations, Goldman Sachs remained profitable during one of the most challenging years in our industry’s history.”

Well, much to its benefit, Goldman was able to release the bad quarterly results on a day in which the Fed dropped rates to the historic low range of 0% to .25% at the FOMC meeting. Today, the Fed’s interest rate news seems to be getting more attention from stock investors than Goldman’s worse-than-expected quarterly results for the shares are actually up 11% in early afternoon trading. We fear that Morgan Stanley (MS), who reports tomorrow, may not be so lucky. Morgan Stanley is participating in today’s broad rally in financials and is actually up more than eight percent. However, tomorrow is a new day and it is likely that MS will announce painfully weak results to a much less receptive market.

GSExpect to see down revenues across the board from Morgan Stanley tomorrow, much the same as they were for Goldman. Because of the credit crisis, there is simply less business in every area for investment banks–particularly on the deal side. This has necessitated that both Goldman and Morgan thin their workforces in order to cut costs in these lean times. For a telling sign of the times, average compensation at Goldman Sachs is down 45% from last year, to only $363,654 (how do they make ends meet?). Morgan was one of the banks that had significant exposure to the subprime mortgage market when that meltdown started and the firm has made a huge effort to reduce its exposure to such risky debt. Analysts expect Morgan Stanley to lose $0.34 per share and, even more troubling, also expect it to post negative revenue for the quarter from losses in trading and other operations.

Morgan StanleyOnly three months ago Goldman and Morgan were expected to earn $4.00 and $1.10 per share respectively. Needless to say, there have been countless revisions downward since that time. These firms were allowed to operate with up to 30x leverage for many years, which inflated profits in boom times but such times are long gone. At Ockham, we do not put out earnings estimates, but it is clear that the two remaining major independent brokerage houses are in one of the most challenging environments in history. The air of Goldman infallibility is little more than a memory as the company has lost two-thirds of its market value in the last year. Here’s to hoping that Morgan exceeds expectations but it would not be surprising to see the market punish Morgan tomorrow for any slip-up and short interest in its stock has been growing this week. Both of these company’s are undervalued compared to historical valuations but, these days, financial stocks are only for the bravest of investors. They are simply to risky and volatile to merit our recommendation at this time.

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Ockham Research is an independent equity research provider based in Atlanta, Georgia. Security analysis at Ockham Research is based upon the principle known as Ockham's Razor, named for the 14th- century Franciscan friar, William of Ockham. The principle states that a useful theory should utilize as few elements as possible, because efficiency is valuable. In this spirit, our goal is to make the investing environment as simple and understandable as possible, yet no simpler than is necessary.

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