Better Buy: Bank of America Corporation vs. Goldman Sachs

By Markets Fool.com

Bank of America (NYSE: BAC) and Goldman Sachs (NYSE: GS) are two of the most high-profile names in American finance. Both are powerful, heavily capitalized enterprises whose money helps grease the wheels of this country's economic system.

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They are among the major players in their respective segments of the finance industry, but only one can be the superior stock investment. Read on to see which company I think that is.

Banking on better times

The two are among the top dogs in their respective specialties. Bank of America is, of course, one of the nation's "big four" incumbent lenders. Although it holds a powerful investment banking asset in the form of storied Merrill Lynch (which it bought in 2008), its core business is its commercial and consumer lending operations.

On the flip side, although Goldman Sachs has some fairly limited commercial banking operations, it is at heart an investment bank. Make that the investment bank, as it routinely tops the lists for some of the key IB activities like IPO underwriting, mergers and acquisitions, and the like.

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Both companies have been doing well of late. Bank of America's Q3 saw the lender post net revenue that was 3% better on a year-over-year basis (at $21.6 billion), and net income that improved 7% to just under $5 billion. Both line items comfortably beat analyst estimates.

Many other line items moved in the right direction, including costs, which declined by 3%. Ripping a page from the better investment banks, the company increased its overall securities trading revenue by 14%.

Speaking of top IBs, Goldman Sachs saw much stronger growth in its operations for the same quarter, with revenue rising by 19% and net income advancing a powerful 58%. This was, admittedly, helped by a weak Q3 2015, but still the company blew well past analyst estimates for this most recent period.

The performance of both companies was particularly encouraging given that they both face significant headwinds, the stiffest of which are persistently low interest rates, and a challenging regulatory environment that is tougher and more expensive to comply with than in the past.

Two bulls on the prowl

Investors are equally impressed with what they see from both Bank of America and Goldman Sachs. The share prices of the two companies have been moving more or less in concert in recent months, with each up by around 11% so far this year.

That's not surprising, given that roughly the same level of optimism surrounds both. More concretely, a number of their key valuations -- return on equity, return on assets -- are very close, or at least in the same general neighborhood.

One figure that catches my eye, though, is the P/E to growth ratio. Here's where we see a big difference: analysts are projecting a sharper rise in earnings for Goldman Sachs, as that company's PEG ratio is a very low 0.70. This is less than half of the 1.45 Bank of America currently sports.

That stands to reason, in my opinion. Goldman Sachs has better potential for lifting its bottom line; political/economic shocks, such as Brexit or Donald Trump's surprise victory, tend to juice securities trading.

There's no telling whether the dawning of the Trump era will keep up volumes in this country, but we haven't seen the end of the Brexit story in Europe. Most likely the continued financial fallout from that event will keep trading lively, and encourage cross-border mergers. Both trends play very well to Goldman Sachs' strengths.

On paper, Goldman Sachs has less to gain from rising interest rates, as these tend to dampen classic IB activities such as M&A and debt underwriting (a higher cost of debt theoretically makes companies more hesitant to borrow). However, keep in mind that rates are at historical lows, so even if they go a bit higher, we'll still be in a world full of cheap money. I don't anticipate a huge drop-off in lending at all.

This Fool's pick

I'm a fan of both Bank of America and Goldman Sachs right now. On a fundamental basis, the companies are performing above expectations -- the latter significantly so -- and those stock price rises are modest, leaving their shares undervalued.

But of the two, I'd rather put my funds into a purer-play investment bank, as I think that's where much of the action will be in the financial sector over the coming months and perhaps years. Goldman Sachs is that purer play in this contest, and it's the stock I'd prefer as an investment.

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Eric Volkman has no position in any stocks mentioned. The Motley Fool recommends Bank of America. 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.