Morgan Stanley: Best-In-Class Stock Performance After Q3 Earnings
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Summary:
- Morgan Stanley’s earnings surpassed expectations, driving a 6.5% stock surge. Strong performance in all segments led to the company gaining the highest one-day return compared to the other banks after reporting Q3 earnings.
- Despite a positive investment banking outlook, the stock remains expensive, with a PE of 18.1x and a PEG of 2.48x.
- Given the outlook, rapid growth, and valuation, I reiterate my “buy rating” on Morgan Stanley’s stock.
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Morgan Stanley’s (NYSE:MS) stock ended the trading day with a stunning 6.5% jump after reporting Q3 earnings that vastly exceeded analyst expectations. In my previous analysis of their stock, I covered how Q2 earnings also came in that well, and that momentum has been reiterated once again.
When analyzing the other major investment banks that reported this week and the previous, all exceeded earnings expectations, but not to the extent of Morgan Stanley, which is why the stock rose substantially.
A Summary of What Explained MS’s Rise
To start, total revenues were exceeded by a stunning $1.09 billion or 7.6%, and diluted GAAP EPS was 19.0% higher than what analysts expected. Other items, such as FICC and equity trading revenues, also surpassed forecasts by 8.1% and 13.0%, respectively. Last, net interest income was 17.6% higher than anticipated, even though management saw challenges ahead in Q2 due to increases in sweep accounts funding costs.
MS: Strong YoY Growth in All Segments
Of course, Morgan Stanley’s largest segment is Wealth Management, which is what they are most known for. With $7.27 billion, the company achieved an outstanding revenue rise of 7.1% from the preceding quarter and a 13.6% rise YoY. A surge of that magnitude wasn’t seen since Q4 ’22 when the general asset prices started to recover.
In the press release, management attributed this growth to strong asset management and transactional revenues, adding $64 billion in client assets and reaching an AUM of $6 trillion.
Following, Institutional Securities (mainly IB and trading) maintained their elevated YoY growth at 20.3% and continued the momentum exhibited in Q2, setting quarterly revenues at $6.82 billion. This segment was -2.3% down for the quarter, but its yearly results tell a different story, and it is undoubtedly the most volatile component of the top line. Here, the segment’s main catalysts were strong performance in fixed-income underwriting (120% YoY) and equity trading (51% YoY), partially countered by a slight rise of just 1% in fixed-income trading.
Finally, Investment Management also performed excellently. Here, MS achieved $1.46 in revenue, with these growing at 5.0% QoQ and 9.0% YoY, driven by a sequential rise of 5.5% in asset management-related fees and positive net flows of $7 billion, bringing total AUM attributable to the Investment Management segment to $1.6 trillion.
Morgan Stanley: Growing Faster Than the Diversified Banks But Matching Stock Returns
| Q3 ’24 Revenue (YoY) | Q3 ’24 EPS (YoY) | |
| Morgan Stanley | 15.9% | 36.23% |
| JPMorgan | 7.0% | 0.9% |
| Bank of America | 0.4% | -10.0% |
| Wells Fargo | -2.4% | -4.0% |
Source: Seeking Alpha| FinChat
Morgan Stanley’s current one-year performance, including today’s surge, is approximately 52%. This performance is quite similar to that of more lending-focused banks such as JPMorgan (JPM), Wells Fargo (WFC), and Bank of America (BAC). Yet, these banks have been experiencing larger headwinds in non-interest income, which are being countered by strong positive fee income in investment banking and trading, the component in which MS derives most of its revenues.
Although it is riskier to be less diversified, Morgan Stanley’s heavy fee income structure allows it to benefit from the current landscape and witness elevated revenue rises of 15.9% YoY, which are far higher than those of the other diversified banks.
Positive Investment Banking Outlook Going Forward
Despite investment banking activities growing solidly year-over-year at 56%, compared to historical averages, deal activity remains below historical averages, particularly within advisory and equity capital raising. This provides Morgan Stanley with enough room to continue growing this unit higher while also being helped with an expected decrease in the cost of borrowing.
Furthermore, CFO Sharon Yeshaya provided a positive outlook and shared their belief that the industry is at an early stage of a multi-year capital markets recovery.
“Pipelines are healthy and diverse. We continue to believe we are in the early stages of a multi-year capital markets recovery. Corporate activity is gaining momentum, and the desire among sponsors to transact is steadily materializing, not only domestically but also abroad”.
CEO Ted Pick also made some comments regarding the constructive IB outlook.
“Improved underwriting markets combined with increasing participation among financial sponsors and corporates across Investment Banking support a constructive outlook. A broadening equity market and evolving interest rate policy are favorable backdrops for our markets businesses.”
The Stock of Morgan Stanley Remains Expensive
With a trailing diluted GAAP EPS of $6.57 and a share price of $119.51, the stock doesn’t necessarily look cheap at an 18.2x price-to-earnings multiple. Partly skewed upwards due to FDIC special assessment-related costs in Q4 and Q1.
In addition, the absolute valuation is even less attractive considering that its five-year historical average has been significantly lower at 12.7x, and its closest peer, Goldman Sachs (GS), has a lower multiple valuation of 15.3x. On a forward basis, things remain similar due to a forward price-to-earnings multiple of 16.2x, which is 29.1% higher than the historical average.
Last, considering the most recent TTM EPS growth was approximately 23%, the expected next twelve-month TTM EPS needs to be 81% of that to obtain a PEG ratio of 1. Currently, the expectations are for a TTM EPS growth of 11.7%, implying a high PEG ratio of 2.48x.
Risks to a Bullish Thesis
The main risk, of course, is that these expectations of better deal activity don’t materialize or not to the extent to which actual fast-growing revenues could be matched. At the end of the day, a stock moves higher based on growth rates and not on absolute levels. So if, for example, a company’s revenues move from 1 to 2, the market share price will significantly gain more than if it moves from 10 to 11. Therefore, matching the actual elevated growth rates will become more complex going forward.
What is currently a tailwind for Morgan Stanley is a headwind for Wells Fargo and is the split between interest income and fee income. MS is currently concentrated on fee income, while WFC is weighted more towards interest income, although it is still diversified. In a hypothetical situation where, generally, for money center banks, the net interest income starts soaring faster than fee income, Morgan Stanley (and potentially Goldman Sachs) would underperform the other money center banks. The same factors that are making GS and MS outperform could be the ones that cause them to underperform in financial performance.
Summary and Stock Rating
Q3 was an excellent quarter for Morgan Stanley; therefore, the stock price reaction was more than justified. With the current landscape of market recovery in global investment banking, the business unit has enough room to continue exhibiting high growth in deal activity while deals remain below historical averages.
On the wealth management and investment management side, the upside is more limited due to elevated markets, particularly within equity. Yet, the net inflow momentum could help boost AUM or alleviate it if markets fall. At the same time, the company is continually investing in launching private market products for high-net-worth clients to attract ongoing demand, combined with tools for advisors to serve clients within private markets.
If the valuation weren’t a problem, after these earnings, I would’ve upgraded my rating from a “buy” to a “strong buy” without any doubt. But at a PE of 18.1x and a PEG of 2.48x, I need to be prudent and put this into my overall rating. Since I believe there is strong momentum on the company’s fundamentals and market sentiment could act as support for a stock that has outperformed the S&P 500 by 18.22% (1Y), I reiterate my “buy” rating on Morgan Stanley.
Analyst’s Disclosure: I/we have a beneficial long position in the shares of JPM either through stock ownership, options, or other derivatives. 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.
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