Inside Goldman's Earnings Miss

Goldman Sachs
Goldman Sachs

Goldman Sachs

(GS) reported second-quarter earnings of $1.09 billion, or $1.85 per share. These results are below expectations, and were driven downward by an 18% year-over-year drop in revenue.

Whenever these numbers are announced, I like to crack open the company's supplemental data and see exactly where those earnings came from. Broken out by division, here's Goldman's revenue in the most recent quarter and the year before:


Net Revenue, Q2 2011

Net Revenue, Q2 2010

Investment banking

$1.5 billion

$941 million

Institutional clients (trading)

$3.5 billion

$5 billion

Investing and lending

$1.0 billion

$1.8 billion

Investment management

$1.3 billion

$1.1 billion


$7.3 billion

$8.8 billion

Source: Company filing.

Within the institutional clients division, Goldman's most important line of business, the revenue drop was fueled almost entirely by a 53% plunge in fixed-income, currency, and commodity trading.

Goldman's clients -- hedge funds, pension funds, and other wealthy investors -- likely scaled back on trading, and the spread between short- and long-term interest rates on bonds became less favorable. FICC, as this trading segment is called, drove the bulk of Goldman's earnings in recent years after the financial crisis created massive trading opportunities for its clients, and competition from Bear Stearns and Lehman Brothers vanished after the two were acquired and went bankrupt, respectively.

Known for managing its balance sheet more astutely than competitors, Goldman's tier 1 capital ratio -- a key measure of a bank's ability to withstand future losses -- stood at 14.7% in the second quarter, which is high by industry standards.

Unlike some competitors, Goldman values all of its trading assets at the going market price -- a practice called mark-to-market -- rather than creating its own judgment of their worth. This, CEO Lloyd Blankfein once wrote, "was a key contributor to our decision to reduce risk relatively early in [the financial crisis] and in instruments that were deteriorating."

While still the most venerable Wall Street bank, Goldman's quarterly earnings underline a key trait of the investment banking industry: Results can be exceedingly volatile. Markets give high valuations to companies that produce stable, consistent results, and Goldman delivers anything but.

Motley Fool contributor Morgan Housel doesn't own shares of any of the companies mentioned in this article. Follow him on Twitter @TMFHousel.