Many people think that all Wall Street firms are alike. The assumption is these investment banks all operate the same, in a what amounts to a commodity market. However, this is not the case, as risk profiles can change markedly from one firm to the next and what they choose to do can also vary dramatically. In this article, we'll examine three of Wall Street's pure investment banking powerhouses.
It may not be fair to the company, but Goldman Sachs (NYSE: GS) has become the standard by which every other firm is judged. Goldman Sachs has changed over time, from a typical Wall Street brokerage firm advising high net worth individuals and corporations, to a very dynamic investment banking and proprietary trading firm. In fact, the majority of the firms revenue comes from trading and investing the firms own money.
Goldman Sachs has a world-class investment banking unit, perennially ranking at the top for merger-and-acquisition activity, and equity and debt underwriting. Goldman also has one of the top prime-brokerage units, those trading desks that cater exclusively to hedge funds. The firm has a very strong brand name that helps it gather assets for its asset-management group as well.
Goldman's financial results are remarkable, with the firm earning a net margin of 25% while seeing a year-over-year growth in earnings per share is over 75% and a return on equity of just over 33%. One has to hope the firm's trading acumen is as sharp in bear markets as it is in bull markets.
Mack is Back
John Mack is back at the helm of Morgan Stanley (NYSE: MS) and the performance of its shares would tell you as much. Prior to his return, the firm had an overly conservative management that put the firm's traders and in fact the whole firm, in irons. Wall Street firms get paid to take risks - that's what investment banks do. The old management didn't seem to understand this concept. The return of John Mack has been the resuscitation that the firm needed in its restructuring.
In the process of spinning off its Discover credit card business, Morgan Stanley, at this point in time, is something of a hybrid - a combination of proprietary trading firm like Goldman Sachs and retail brokerage firm akin to Merrill Lynch (discussed next). Financially, the firm has done well with a growth in earnings of 47% year-over-year contributing to a net margin of 23.5% and a return on equity of 25.5%.
Morgan Stanley does have some catching-up to do, as the previous management with their ultra-conservative attitude put the whole firm behind the curve in the mortgage business and equity derivatives. In addition, the firm has to ramp up its asset management capability and the average production of its retail producers.
Merrill Lynch (NYSE: MER) has adopted an approach where it takes care of a client's whole financial picture, not just its investment portfolio. Because of that, MER has the highest producing retail brokers and financial advisors on Wall Street - on $1.6 trillion in assets. This retail power is what distinguishes MER from other firms. MER also has a capable capital markets group and always ranks near the top with its investment banking business.
By having such a formidable retail army, MER is well positioned to take care of the retiring baby-boomers that just started turning sixty last year. The firm can also take on huge amounts in investment banking syndicates because the tremendous distribution that retail army has.
Merrill's financial results have been in line with other firms, with earnings growing 47% year-over-year, producing a net margin of not quite 25% and a return on equity of 25%. The question is, what will all those retail accounts do if we ever see a bear market?
An old cliché on Wall Street is "don't confuse brains with a bull market." Believe it or not, this quip is suprisingly accurate. Most people are naturally optimistic and like to buy stocks and only sell out of fear, desperation or panic. The Street knows this and devotes a considerable amount of time and effort training its brokers and advisors how to recognize and deal with certain personality types.
Trading is inherently very risky business, and one has to assume that Wall Street professionals know what they are doing. You can bet they are fully hedged. Still, sometimes you can't get out of the way fast enough.
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