The good ol’ days to be a bank may be over. But not all financial institutions are made equal. Think of Morgan Stanley (MS) as an example.
The company has little, if any, exposure to the fragile broad consumer segment. About 40% of the company’s revenues come from wealth management, plus at least as much from institutional clients – i.e. investment banking, sales and trading. All of these businesses should be performing better in 2020 than those that are more exposed to the low interest rate environment and potentially deteriorating consumer credit quality.
But of course, the proof is in the pudding. Morgan Stanley will have its chance to prove my optimism right (or wrong) when it reports third-quarter earnings. The numbers should come out around mid-October, during financial services earnings season.
Credit: Morgan Stanley
What to expect
Analysts expect to see revenue rise a timid 5% to $10.5 billion, which would represent sharp growth deceleration compared to a strong second quarter. Consensus EPS of $1.28, if achieved, would be nearly flat YOY (see graphs below). Certainly, at least due to the lumpy nature of the institutional services business and the unpredictable nature of this pandemic year, actual results could deviate widely from these projections.
Last quarter, record-breaking trading volume and a spike in capital raising activity helped to lift Morgan Stanley’s revenues to the highest level ever, by far. Lack of meaningful exposure to unsecured consumer loans, emerging markets and small- to mid-sized clients also helped in a time of market and economic instability.
Source: graphs by Seeking Alpha
Because the overall landscape has not changed much in the past three months, I would be surprised to see Morgan Stanley’s financial performance deteriorate much this time. To be fair, results within the institutional segment will depend in great part on the bank’s deal pipeline, the pace of sequential reduction in underwriting and overall trading activity. But at least the large wealth management piece of the puzzle should continue to benefit from client assets rising, while E-Trade should soon (fourth quarter, to be precise) begin to add diversification to Morgan Stanley’s top line.
Alongside last quarter’s results, I expect to see a discussion around the evolution of the business model during the earnings call. This year alone, Morgan Stanley has made two high-profile acquisitions, the last of which only a few days ago – Eaton Vance.
It will be interesting to hear about the management team’s longer-term vision and expectations. Morgan Stanley is about to become much more of a wealth and investment management and services company, in contrast to the institutional securities powerhouse that it was only 10 years ago (74% of pretax profits).
Bull or bear?
I appreciate Morgan Stanley’s decade-long business model transformation that has accelerated this year. In the more immediate term, I also like the bank’s position relative to the rest of the space. For the same reasons that I am highly cautious of pure-play consumer banking names like Capital One (COF), I am much more open to considering stocks of an institutional- and high net worth-heavy bank like Morgan Stanley.
Last time I wrote about the company on Seeking Alpha, I expressed some concerns over valuations. I observed that an investment in MS tends to pan out when market cap lags book value, and that both metrics tend to converge over time. Today, the former is still ahead of the latter, but not by much and only since the stock price spike of May through July 2020 (see graph above).
Due to the combination of (1) a promising business model transition, (2) superior positioning within the financial services space in 2020 and (3) valuations that do not seem overly stretched, I believe MS is a stock worth considering.
Beating the market by a mile
I do not yet own MS because I have been focused on creating superior risk-adjusted returns in the long run using a different strategy. To dig deeper into how I have built a risk-diversified portfolio designed and back-tested to generate market-like returns with lower risk, join my Storm-Resistant Growth group. Take advantage of the 14-day free trial, read all the content written to date and get immediate access to the community.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.