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Goldman Sachs Earnings Reflect Banking Sector's Troubles

Stocks in this article: GS JPM

NEW YORK (TheStreet) - Goldman Sachs'  (GS) far better-than-expected second-quarter earnings are a quagmire for the entire financial services industry. Recovering markets across all asset classes continue to do little to help the shares of Goldman and other large securities firms, which have all dramatically underperformed a stock market recovery since the financial crisis.

In Goldman's case. the quagmire is especially acute. The bank's revenue, earnings and compensation all benefited from near-record upward marks to the firm's $65 billion "Investing & Lending" portfolio of private equity, debt and equity investment. Still, Goldman Sachs shares barely reacted to the firm's earnings results, which came in about 30% ahead of Wall Street consensus.

Goldman Sachs Leans Heavily on Private Equity as Volcker Looms

Goldman earned $4.10 a share on revenue of $9.13 billion, 32% ahead of consensus estimates of $3.09 in EPS and a rise in revenue when analysts had expected a drop. The firm did benefit from better-than forecast investment banking revenue of $1.78 billion, strong trading revenue of $3.83 billion and in-line asset management revenue of $1.44 billion.

But, once again, it was Investing and lending gains that drove the bulk of Goldman's earnings beat.

The firm's Investment & Lending division earned $2.07 billion in revenue, a 46% rise from year-ago levels, helping the company to an unexpected 6% rise in overall revenue. Those Investment & Lending results were nearly $600 million ahead of estimates from Bernstein, Nomura, Wells Fargo, Barclays Capital & Deutsche Bank compiled by Bloomberg.

As a result, Goldman shares reacted to the dramatic earnings beat as they normally do -- with little movement.

Goldman was rising 1.3% to $169.13 in early trading on Tuesday. However, the company's shares remain down year to date when including dividend payments, dramatically underperforming both the Dow Jones Industrial Average and S&P 500. Over the past 12 months, or in virtually all time frames over the past five years, the story is similar.

To Goldman's credit, the firm appears to understand that beating analysts' estimates won't be enough for shareholders.

This quarter, Goldman did not use its better-than-expected results to boost overall compensation ratios. Compensation expense as a portion of revenue remained at 43%, but it did rise to nearly $4 billion for the quarter, given the bank's 6% rise in quarterly revenue.

The firm also continued to be a significant net repurchaser of shares. During the second quarter, Goldman spent $1.25 billion to repurchase 7.8 million shares. The firm's diluted share count fell 2% in the quarter to 475.9 million from 484.6 million in the first quarter.

Since the end of 2010, Goldman has used share repurchases to lower its overall share count by 110 million shares, or nearly 19% of its total diluted shares outstanding.

Faced with continued strong earnings beats attributable to businesses like Investing & Lending that may not be as large in coming market cycles, Goldman has had the discipline to keep its expenses under control and return capital to shareholders through consistent stock buybacks and rising dividend payments.

The same can't always be said for other lenders, and even some top performers such as JPMorgan (JPM) and Wells Fargo (WFC).

Headlines on Tuesday will focus on solid trading performance and continued strength in investment banking in light of big earnings beats from Citigroup (C), Goldman and JPMorgan.

On a media call, JPMorgan indicated that strong trading at the end of the quarter didn't carry over into the third quarter. Citigroup made a similar refrain on Monday. Such are the winds of quarterly trading results.

But as Goldman keeps expenses in line and continues to reduce its overall share count to reflect its business opportunities, there is a story for financial services investors. The private-equity and alternative asset management industries continue to pick up businesses shed by Wall Street securities dealers. and gains they record on PE, distressed debt and other investments are treated as sustainable by the investor community.

Goldman's second-quarter earnings, driven by a near record quarter for Investing & Lending, may say little about the health of investment banks. It, however, should augur very positively for the units of publicly traded PE firms such as KKR (KKR), Blackstone Group (BX), Carlyle Group (CG), Apollo Global Management (APO) and Oaktree (OAK).

Bottom Line: A continued rise in global markets in the second quarter did little to reverse the underperformance of banks. Alternative asset managers, however, may be poised for strong earnings.

Hedge Funder Sees KKR's Next Deal In Washington Mutual's Shell

TheStreet's Top 5 Dealmakers

-- Written by Antoine Gara in New York

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