What to Watch in Goldman Sachs' Earnings Report

By Markets Fool.com

Goldman Sachs is set to report earnings Friday, and there are a few key details investors should keep an eye on besides whether the company misses, meets, or exceeds the market's earnings expectations. The details behind the numbers are what matter most.

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Source: Goldman Sachs.

Specifically, Goldman Sachs has performed well during the first three quarters of 2014, and investors should look for signs indicating whether we can expect the same growth going forward.

Investment banking
Investment banking has been a huge driver of growth not only for Goldman, but for the investment banking industry as a whole. IPO and M&A activity has been incredibly strong recently, primarily because of the surging stock market and the U.S. economic recovery, and this could be a big boost to Goldman's earnings if it continues in 2015.

When the stock market gets expensive, private companies have a greater incentive to go public, as their shares can fetch a higher price. And in a thriving economy, companies are also more likely to buy out their competitors, as a strong economy produces earnings growth and makes it easier to borrow money to finance deals. Companies are also more likely to agree to be bought out when their share price is high and they can command a lofty price for their shareholders.

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So, if the market stays strong in 2015, we should see this continue. During the third quarter, Goldman's investment banking division produced a fantastic 26% year-over-year revenue increase. I'm curious to see whether they kept it up in the fourth quarter, but I'm equally curious to hear any comments from management regarding their outlook for the coming year.

Growing in the right ways
It's important to determine whether a bank is growing because its business is improving or because a rising economic tide is simply lifting all boats.

For example, when the stock market is in a six-year bull market, as it is now, a firm's assets under management will grow substantially due to market performance alone, resulting in a lot more fee income and commissions. And this is indeed the case, as Goldman's assets under supervision have grown from $849 billion to $1.15 trillion since the end of 2009.

A better measure of growth is to look at the net flow of money. A net inflow of money means that more people are depositing money than are withdrawing money, and a net outflow means the opposite. During the last quarter, Goldman saw net inflows of $20 billion, so either it's getting new clients or its existing clients are letting the firm manage more of their money. Either way, this is the right way to grow.

Another thing to look at is Goldman's market share, particularly in areas of the business such as investment banking. During the third quarter, Goldman's M&A market share grew by 300 basis points to 29%.

So keep an eye on statistics like these to determine whether Goldman is growing in the right ways.

Share buybacks
Goldman Sachs has never really been a high-dividend stock. So when the company announced with its third-quarter earnings that it was raising the quarterly dividend to $0.60 per share for a 1.3% annualized yield, it didn't exactly make income investors excited. However, people who only see Goldman's low dividend don't know the whole story.

There are two main ways that companies return capital to shareholders: dividends and share repurchases. Goldman prefers the latter. Companies generally repurchase their shares because management feels that the shares are attractively priced and that the best way to deliver value to shareholders is to repurchase those shares and reduce the outstanding share count. Since the end of 2010, the number of outstanding shares has dropped by about 23%.

Year GS Outstanding Shares
2010 585.3 million
2011 556.9 million
2012 516.1 million
2013 499.6 million
2014 452.8 million

Source: S&P Capital IQ (note: 2014 data current as of Q3).

During the third quarter alone, Goldman bought back 7.1 million shares, or about 1.6% of the total. This represents a 6.4% annual buyback rate. Look for any information indicating whether this has continued during the fourth quarter and will continue going forward.

Wait and see
Goldman has produced strong results lately, and the share price has grown accordingly. In fact, since the beginning of 2012, shares have nearly doubled. However, so long as the company keeps performing, it's hard to make the case that Goldman is a bad value. At the current share price, it's valued at just 1.17 times its book value and less than 11 times 2015's expected earnings.

So long as it continues to perform as it has recently, Goldman could definitely be a long-term winner.

The article What to Watch in Goldman Sachs' Earnings Report originally appeared on Fool.com.

Matthew Frankel has no position in any stocks mentioned. The Motley Fool recommends Apple and Goldman Sachs. The Motley Fool owns shares of Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.