Why Goldman’s Stumble In This Year’s Fed Stress Test Isn’t A Cause For Concern

The Fed’s stress test for this year turned out to be less than ideal for Goldman Sachs (NYSE:GS), as the investment bank saw its leverage ratio figure fall below the required minimum under the severely adverse scenario of the test – resulting in a conditional approval for its capital plan. This means that Goldman’s total payout to shareholders over the next four quarters can only be as high as its total payout over the last four quarters. To clear up the uncertainty stemming from the conditional approval, Goldman broke from tradition to provide investors with details about its proposed plan for the next twelve months. The plan entails dividend payments of $1.3 billion between Q3 2018 and Q2 2019, and share repurchases of $5 billion over the period – for a total payout of $6.3 billion.

Notably, this is a sizable reduction in payout from the $8 billion figure for full-year 2017. However, the reduced payout wasn’t completely unexpected. In fact, with the Fed modeling a much steeper decline in equity market valuations as a part of this year’s stress tests, investors expressed concerns about its impact on the more trading-focused banks – Goldman and Morgan Stanley in particular – when the Fed detailed the test scenario in February. These concerns were reinforced a couple of weeks ago when the Fed released results for the quantitative phase of the test, with both these banks witnessing the sharpest decline in capital ratio figures under the severely adverse scenario. The lower payout, therefore, can be largely attributed to a more stringent stress test, rather than any inherent weakness in Goldman’s capital structure. Although the lower payout from Goldman is bad news in terms of cash returns to shareholders and will also weigh on its return on equity figure for the year, it looks like a prudent move in terms of long-term sustainability.

We capture the trends in Goldman’s dividend payout as well as share repurchases over the years in an interactive dashboard, along with our forecast for these key metrics.

Understanding Goldman’s Shareholder Payouts Over The Years

Goldman has had a history of paying a small amount of dividends to shareholders, although it more than made up for this by buying back billions of dollars worth of shares each year. The investment banking giant has steadily raised dividends since 2012 – up from 32 cents a quarterly then to the current figure of 80 cents a share. The bank’s dividend yield, however, has largely remained around just 1%.

Over the last ten years, Goldman has returned $55.2 billion in cash to common shareholders, an average of $5.5 billion a year – representing about 88% of its average retained earnings of $62.9 billion for this period. At the same time, Goldman’s preference for share repurchases is evident from the fact that the total dividend payout over this period has been less than $10 billion, while share buybacks have cost the bank $45.5 billion.

The chart below details Goldman’s total shareholder payout for each year since 2012, and includes our forecast for the next four years.

A Detailed Look At Payouts

Goldman announced dividends of 80 cents a share for Q1 2018, and the conditional approval means that it will retain dividends at this level until Q1 2019 (with a proposed hike to 85 cents in Q2 2019). Accordingly, total dividends for the year are expected to be $3.20 per share. Assuming that Goldman’s average share count for this year is around 385 million, its dividend payout for 2018 is likely to be $1.2 billion. Also, the bank repurchased $800 million worth of shares in Q1 2018 and opted against buying any shares in Q2 (to nullify the impact of the new tax law on its capital). Taken together with $2.5 billion in proposed purchases for the rest of the year (half of the total proposed repurchases of $5 billion), this points to total share repurchases of $3.3 billion in 2018. Goldman’s total payout for full-year 2018 is therefore expected to be around $4.5 billion. Notably, this represents a total payout ratio of just under 55% for the bank using our estimate of $8.3 billion for net income this year – making this the lowest payout by Goldman in dollar terms as well as payout ratio since 2009. However, we believe that the reduced payout is a one-off event, and Goldman should continue to return roughly 80% of its income to shareholders over coming years.

We represent dividend payouts and share repurchases in our analysis of Goldman Sachs in the form of an adjusted dividend payout rate, as shown in the chart below. You can see how a change in the bank’s policy of returning cash to investors affects its valuation by making changes here.

If you don’t agree with our forecast, you can come up with your own by making changes to our interactive dashboard for Goldman’s dividend payout and share repurchases.

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