The Future of Banking at Goldman Sachs

Strangely enough the future of banking and finance is on display at Goldman Sachs (NYSE: GS). The 147 year-old investment bank is quietly transforming itself into an information technology company, a paradigm shift that will be felt far beyond Wall Street.

Today’s Goldman Sachs looks more like Alphabet: (NASDAQ: GOOG); the company formerly known as Google, than a traditional investment bank. It employs 9,000 computer engineers and just two equity traders, the MIT Technology Review reported.

That investment is starting to pay off with a high level of automation; which might make Goldman Sachs as profitable and as valuable as Alphabet (NASDAQ: GOOGL). The technological investment makes GS a very good value investment that’s about to get a lot better.

How Technology Makes Goldman Sachs a Great Investment

Marty Chavez, Goldman Sachs’ former Chief Information Officer (CIO) was recently promoted to deputy Chief Financial Officer (CFO). Chavez predicted that many “front end jobs” such as sales, investment banker and analyst positions will be phased out next in a talk at Harvard’s Institute for Applied Computational Science in January.

That might lead to huge savings for Goldman Sachs because analysts, sales and trading positions at the big 12 global investment banks pay an average of $500,000 a year, the analysts at Coalition estimated. Around 75% of Wall Street compensation goes to front end employees whose jobs are next on the chopping block, Amrit Shahani, the head of research at Coalition estimated. Also on the way out might be mergers and acquisitions specialists who make $700,000 a year.

Such developments are very bad news for Harvard and Wharton Business school students. Yet they might be very good news for Goldman Sachs stock holders; who may see the bank generate more cash and value than ever before with far lower operating costs.

The Value in Artificial Intelligence

The key to Goldman Sachs’ future profits is machine learning; the technology that is the basis of artificial intelligence. Machine learning occurs when an algorithm actually learns to understand a task rather than simply repeat it.

Today’s digital tools; such as trading robots. can mindlessly and perfectly repeat a simple task such as buying or selling equities. Yet they cannot understand what is going on or learn from the process the way a human can. Everything a trading robot does has to be programmed into it by a human.

GS is at the forefront of efforts to develop tools that learn, for example a trading algorithm that can analyze each trade in order to identify profitable patterns. Instead of just buying and stocks, such an AI might be able to anticipate market movements.

Marcus, an Example of Banking’s Future

One example of AI at Goldman Sachs is Marcus; a loan platform named for the bank’s founder, Marcus Goldman. Marcus processes applications for debt consolidation loans without human involvement. Instead it uses proprietary criteria based on behavior analysis to identify the most creditworthy applicants.

The big advantage to this is that Marcus might identify potentially profitable loans that a human banker would reject. More importantly it can process a debt consolidation application online in just three minutes, enabling the bank to reach nontraditional customers all over the county; and expanding its market without hiring more bankers.

It is solutions like Marcus that are the future of banking and Goldman Sachs has the resources to deploy them. If such technology works it will make the bank more valuable, which is great news for shareholders because GS is already a great value investment.

Goldman Sachs is Already a Great Value Investment

The financial data shows that Goldman Sachs is already great a value investment meaning that its technology spending is already paying off in a big way. GS already has a vast amount of cash and float.

Some of the most interesting numbers Goldman Sachs reported on December 31, 2016 include:

  • $121.71 billion cash and short term investments. A new high that marked a $28.27 billion increase over December 2015 when Goldman Sachs had $93.44 billion in the bank.

  • $13.43 billion in cash from financing. This makes technologies like Marcus which have the potential to increase the reach of GS’s financing activities very attractive.

 

  • $9.27 billion in cash from investing.

 

  • $5.57 billion in cash from operations.

 

  • $2.984 billion in free cash flow.

 

  • $7.398 billion in net income.

  • Assets of $860.16 billion.

 

  • All that led to a quarterly profit margin of 28.73% and a diluted quarterly earnings per share (EPS) number of 7.398 on December 31, 2016.

 

This is almost incredible when you remember that Goldman Sachs reported revenues of just $30.16 billion on December 31, 2016. All that cash and Goldman Sachs’ ability to leverage it gives the company an incredible amount of float, perhaps rivaling that of Berkshire Hathaway (NYSE: BRK.B).

A Highly Profitable Business Model

The investment in technology is an example of that leverage and means of increasing the leverage. In its rush to modernize GS may have created or stumbled upon a model of banking for the future.

The model work: like this generate a vast amount of cash and float from investing or financing activities. Reinvest that cash in technology and use the tech to make more money. It is very similar to Google and Amazon’s (NASDAQ: AMZN) business model.

Like Alphabet and Amazon, Goldman Sachs seems to concentrate on cash flow rather than revenue. That gives the huge pile of cash, and a vast amount of float and leverage.

All this sounds good, but skeptical investors will ask does this business model make money for shareholders? The available data from ycharts says yes: Goldman Sachs is definitely paying off for shareholders.

Those shareholders received a return on equity of 9.78% on December 31, 2016. Unlike owners of Amazon and Alphabet, GS shareholders also received a dividend of 65¢ on February 28, 2017.

If history is anything to go by that dividend might be about to grow. On February 26, 2015, Goldman Sachs shareholders received a 60¢ dividend that grew to 65¢ on May 28, 2016.

All this means that Goldman Sachs might now be a technology company, and a technology company that pays a dividend. If you’re looking for a cutting edge finance and technology stock to add to your portfolio Goldman Sachs would be a good choice.