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The Goldman Sachs Group Inc. (GS - Analyst Report) reported its third-quarter 2012 earnings per share of $2.85, significantly surpassing the Zacks Consensus Estimate of $2.18. Moreover, the reported earnings outpaced the prior-year quarter’s loss of 84 cents and prior quarter’s earnings of $1.78 per share.

Amid challenging global markets and European debt crisis, the results were driven by Goldman’s record revenues with an elevation in client activity. Yet, escalated operating expenses acted as a headwind for the quarter.

Net income applicable to common shareholders in the quarter was $1.5 billion, up from $927 million in the prior quarter and loss of $428 million recorded in the prior-year quarter.

Performance in Detail

Total revenue of Goldman more than doubled from the prior-year quarter to $8.4 billion, resulting from an increase in overall businesses, partially offset by lower net interest income. Moreover, revenues were positively impacted by tighter credit spreads and a rise in global equity prices. Revenue also comfortably surpassed the Zacks Consensus Estimate of $7.1 billion.

Quarterly revenue, as per business segments, is as follows:

Investment Banking division generated revenues of $1.2 billion, up 49% year over year. Results reflected higher-than-expected revenues from underwriting business, partially offset by slightly lower revenues from the financial advisory business. Moreover, higher revenues in equity underwriting reflected an augmentation in client activity.

Institutional Client Services division recorded revenues of $4.2 billion, jumping 3% year over year. Results improved due to outstanding performance in Fixed Income, Currency and Commodities (FICC), marked by increased net revenues in mortgages, though offset by reduced net revenues in commodities.

However, fall in equity trading revenues (down 16% year over year) due to lower commissions and fees and reduced net revenues in equities client execution acted as negatives for the division.

Investing and Lending division booked revenues of $1.8 billion in the quarter, surging substantially from negative revenues of $2.5 billion in the prior-year quarter. Results principally reflected a gain of $99 million from Goldman’s investment in the ordinary shares of Industrial and Commercial Bank of China Limited (ICBC), coupled with net gains of $824 million from other investments in equity securities.

Moreover, the segment recorded net interest income and net gains of $558 million from debt securities and loans and other net revenues of $323 million.

However, Investment Management division generated revenues of $1.2 billion, down 2% year over year. The year-over-year fall mainly reflected decreased transaction revenues and management and other fees, partly offset by higher incentive fees.

In the third quarter of 2012, operating expenses ascended 40% to $6.1 billion compared with the prior-year quarter. Higher compensation and benefits added fuel to the fire.

Yet, non-compensation expenses were $2.4 billion in the quarter, down 13% year over year. Expenses decreased largely due to lower levels of business activity and the benefits of continued expense reduction initiatives. Additionally, results included net provisions of $62 million for regulatory proceedings.

Evaluation of Capital

As of September 30, 2012, Goldman’s Tier 1 capital ratio under Basel I was 15%, in line with the prior quarter. Tier 1 common ratio under Basel I was 13.1%, in line with the prior quarter.

Return on common shareholders’ equity, on an annualized basis, was 8.6%. Goldman’s book value per share and tangible book value per share surged to $140.58 and $129.69 from $137.00 and $126.12 respectively, at the end of the prior quarter.

Assets under management (AUM) climbed to $856 billion in the quarter compared with $836 billion in the prior quarter, reflecting net market appreciation.

Share Repurchase and Dividend Update

During third quarter 2012, Goldman repurchased 11.8 million shares of its common stock at an average price per share of $106.17 and a total cost of $1.25 billion. Remaining share authorization under Goldman’s existing repurchase program stands at 34.2 million shares.

Concurrent with the earnings release, Goldman declared its bolstered quarterly dividend of 50 cents per share. This reflects an approximate 8.7% increase in dividend from 46 cents paid in the last quarter. The increased dividend will be paid on December 28, 2012 to common shareholders of record as of November 30, 2012.

Performance by Peers

Citigroup Inc. (C - Analyst Report), one of Goldman’s peers, after reporting decent results in the prior quarter, reported somewhat encouraging third quarter 2012 results. Earnings per share came in at $1.06 for the quarter, comfortably surpassing the Zacks Consensus Estimate of 98 cents on lower loan loss provisions, higher Global Consumer Banking revenues and a drop in expenses.

Another peer, JPMorgan Chase & Co. (JPM - Analyst Report), reported third quarter earnings per share of $1.40, way ahead of the Zacks Consensus Estimate of $1.21. This also compares favorably with $1.02 earned in the prior-year quarter. Despite the impact of a number of legal and regulatory issues as well as fundamental pressures like low interest rate and sluggish loan demand, JPMorgan’s earnings surprise of almost 16% signals good going for the sector.

Our Viewpoint

Overall, the results of Goldman improved significantly compared to the prior-year period, mainly driven by top-line growth. Although the company has reported profits but increased operating expenses remains a matter of concern. Moreover, regulatory issues, including lawsuits and the fundamental pressures on the banking sector, are expected to dent the financials of the company in the upcoming quarters.

However, we expect Goldman to benefit from its well-managed global franchise, strong capital base, and industry leading position in trading and asset management in the near future.

In Conclusion

An investor with an appetite to absorb risks related to the market volatility should not be disappointed with an investment in Goldman over the long haul. Goldman’s fundamentals remain highly promising with a diverse business model and a strong balance sheet.

Moreover, one can consider Goldman to be a value investment due to its steady dividend-yielding nature. Concurrent with the earnings release, the company also increased the quarterly dividend, instilling investors’ confidence.

Goldman currently retains its Zacks #3 Rank, which translates into a short-term Hold rating. Considering the fundamentals, we also maintain our long-term Neutral rating on the stock.

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