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Investors in Morgan Stanley (NYSE:MS) were pleasantly surprised by the bank's fourth quarter results. The strategic direction to focus on the brokerage business and strong presence in equities has paid off with equity markets increasing rapidly in 2013 across the globe.

As the bank trades at parity to its book value, I remain cautious. The bank needs to make much more incremental profit improvements before the valuation becomes appealing enough in my opinion.

Fourth Quarter Headlines

Morgan Stanley reported GAAP revenues of $7.83 billion. Excluding the impact of debt valuation adjustments, non-GAAP revenues came in at $8.20 billion which is up 9.7% on the year before.

Reported GAAP earnings came in at $192 million, down nearly 71% on the year before. Non-GAAP earnings, after accounting for the negative DVA adjustments, totaled $433 million. This is down nearly 56% on the year before.

Reported earnings from continuing operations came in at $0.07 per share. Excluding DVA adjustments, earnings came in at $0.20 per share. This compares to last year's earnings of $0.49 per share. Note that the bank took $1.2 billion in legal expenses, which impacted earnings by forty cents per share. Expenses were related to mortgage litigation and investigations, all tied to mortgage liabilities resulting from the credit crisis.

Adjusted earnings, excluding DVA adjustments and net tax impact of the legal expenses, came in at $0.50 per share. This number beat consensus estimates by five cents.

Details Of The Earnings Release

Morgan Stanley's results were well-received by the market. Investment banking revenues were up 8% to $1.56 billion, and were very strong compared to a weaker third quarter.

Trading revenues of $1.51 billion were unchanged compared to a year ago, which is quite an achievement in relation to its competitors. Revenues at all other segments rose as well while the asset management business approached the $2.5 billion quarterly revenue mark.

To please its bankers, Morgan Stanley boosted compensation and expenses by 10% to $3.99 billion for the quarter. Total non-compensation expenses rose by 49% to $3.90 billion, largely on the back of a $1.2 billion charge in legal expenses.

Looking Back At 2013

Morgan Stanley made great progress in 2013. For starters, the bank reported top line growth of 24% with revenues totaling $32.4 billion. Compensation expenses fell by 10% as a percentage of total revenues to 50%, which is still a large number.

The bank managed to show great operating leverage on the back of this top line growth with compensation expenses rising just 4% to $16.3 billion. Even when factoring in the large one-time expenses, earnings attributable to shareholders came in at $2.8 billion. This compares to a very modest $30 million GAAP loss the year before.

Comeback Kid

Morgan Stanley's shares still have a long way to go. After peaking around $90 in 2007, shares fell to lows of $10 a year later. Ever since, shares traded in a $10-$35 trading range, but shares did see a major dip in 2012. In June of 2012, shares fell to lows of $12 amidst capital worries and ever since shares have tripled over the past eighteen months.

As the bank made a lot of progress in recent years, the bank is still paying out very modest dividends, awaiting the Federal Reserve's approval to increase payouts. The $0.05 per share quarterly dividend provides investors with a very modest 0.6% dividend yield. Back in 2007, Morgan Stanley still paid out a quarterly dividend of $0.27 per share, much more than the annual payments at the moment.

Trading at little below $33, shares of Morgan Stanley have finally returned to trade at or little above book value of $32.29 per share. The bank already trades at 1.23 times tangible book value. The retained earnings boosted the Basel III Tier 1 Common ratio to 10.5%.

Implications For Investors

Morgan Stanley had a very strong quarter as year to date gains of nearly 7% have pushed shares up to little over $33 per share, valuing the bank at $65 billion.

The strategic direction to focus on retail brokerage and asset management, has paid off handsomely, especially with the strong equity markets in 2013. In a staged deal, Morgan Stanley will now be the full owners of the Smith Barney unit, after buying the remaining stake from Citigroup (NYSE:C). The focus on brokerage and asset management was therefore well-timed in an industry which is much less volatile. The traditional strong exposure in equities was a big winner as well, offset by weaker trading.

The bank is now raising its pre-tax profit margins from 20-22% to 22-25% by 2015, providing a boost for earnings going forwards.

While I like Morgan Stanley's progress and strategic direction, shares have moved up a long way making the stock still reasonably expensive compared to its peers in terms of the price-earnings valuation. With the bank already trading at parity to its book value, I don't see enough prospects for further profit improvements to make shares appealing at current levels.

Disclosure: I 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.