Last updated: January 19, 2011 7:23 pm

Goldman/Wells Fargo

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Goldman Sachs is the hottest bank on Wall Street. Wells Fargo’s logo is a 19th-century stagecoach drawn by six horses. Goldman makes almost half its revenues from fixed income, currencies and commodity trading. Wells’s biggest division is quaintly named “community banking”. Goldman is so successful it is simultaneously attacked and courted by Washington. Wells avoids the spotlight. For all these differences, however, shareholders in the two banks have made identical total returns over the past decade: about 100 per cent.

Both banks also released fourth-quarter results on Wednesday. Do they suggest another 10 years of identical performance? Why not? Theoretically, over such long periods returns on shareholders’ funds are constant and mean reverting across every industry. There are also as many unquantifiable threats to Wells’s supposedly more stable business model as there are to Goldman’s. The latter has to cope with disruptive regulatory change. The former is hostage to fragile consumers and businesses at home.

In the short term, however, a brave investor might prefer Goldman. Such a call has nothing to do with a preference for trading over, say, mortgage lending (up 2 per cent annualised versus the third quarter at Wells). Rather, gearing is the key. For the full year 2010, Goldman and Wells reported returns on equity of 11.5 per cent and 10.3 per cent respectively – about the same pathetic return shared by many in the sector. But whereas Wells reported a fourth quarter tier one common equity ratio of 8.4 per cent, Goldman’s was 13 per cent.

Goldman may be comforted by a better-than-average capital position for now. But there is scope to lower this ratio if management feels increasingly confident about the outlook. Other things being equal, more leverage would lift its return on equity relative to Wells.

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