- Recent acquisitions are serving investors well.
- The company has a sound financial foundation as well as a well-funded, rapidly growing dividend.
- Morgan Stanley has excess capital that it can use for acquisitions or return to shareholders.
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If history is a harbinger of future results, then an investment in Morgan Stanley (NYSE:MS) will reap rewards: the shares of this investment bank nearly doubled the returns of the S&P 500 over the last ten years, and the stock will close out 2021 up well over 40%.
Of course, the oft repeated maxim, "past performance is no guarantee of future results" immediately comes to mind.
However, one can make a reasonable argument that the Morgan Stanley of today is a stronger company than that of a decade ago. Recent acquisitions provide the firm with a greater degree of diversification, while the Fed's lifting of limitations on share repurchases, as well as a stronger financial foundation, may point to robust future returns.
A Review and Takeaways From Quarterly Results
When MS released Q3 results in mid October, the firm reported a year-over-year increase in revenue of 26% and a net income growth of 37%. The firm beat analysts' estimates on the top and bottom line with revenue 5.9% above estimates and earnings per share 20.7% above consensus.
Every segment recorded strong growth. Institutional Securities revenue rose 22%, largely driven by investment banking. That business notched its best quarter in history, with revenue increasing 67%.
Wealth Management revenues jumped 28%, largely due to the addition of record net new assets of $135 billion. This represented a year-to-date 10% annualized growth rate from beginning period assets.
Fee-based client assets increased 31%, to $1.75 trillion. Through the first three quarters, investment banking revenue increased 61%, the result of a growth in M&A and IPO activity.
Much of the growth can be attributed to Morgan Stanley's acquisitions last year of E*Trade and Eaton Vance. The addition of E*Trade brought a stream of commissions and fee income. This revenue source can increase during periods of increased market volatility.
How The Acquisitions Of Eaton Vance and E*Trade Are Transforming MS
In October 2020, MS acquired E*Trade in a $13 billion stock transaction. The deal works to increase pretax profits from the Wealth Management business. Unlike the revenues generated by the firm's fixed-income trading and investment banking, Wealth Management tends to provide a steadier stream of income. Following the merger, Morgan Stanley guides for $400 million in cost savings and $150 million in funding synergies.
The Wealth Management division now provides over 40% of company revenue.
Eaton Vance, a provider of investment strategies and wealth management solutions was acquired in March of 2021 for roughly $7 billion in cash and stock. At the time of the deal, Eaton Vance had $500 billion in assets under management (AUM). MS projects cost savings of $150 million from the deal, with the acquisition being neutral to earnings immediately and marginally accretive thereafter.
The combined firms will have $4.4 trillion of client AUM.
While it is common to witness a degradation in a company's financial situation following acquisitions, MS emerged from these deals with a strong debt profile. Perhaps of greater importance is that these deals provide MS with a more diversified business model and a new growth engine.
The wealth management business, which includes E*Trade now, of course, is growing assets at levels far beyond what we've seen. Through the first nine months, this business added over 300 billion of net new assets, compounding growth on a client asset base of over 4.6 trillion, and we believe this is going to be an economic engine for Morgan Stanley for decades to come.
James Gorman, CEO
Valuation, Debt And Dividend
Shares of Morgan Stanley currently trade for $98.44. The average 12 month price target of 21 analysts is $102.06. The price target of the 7 analysts that rated the stock since the last quarterly report is $110.57.
Morgan Stanley's 5 year PEG as calculated by SA at 2.56x. The 5 year PEG provided by Yahoo is 6.14x. This compares to the sector median PEG of 1.02x and the bank's five year average PEG of 1.40x. The forward P/E of 12.58x is above the 5 year average P/E of 11.28x.
MS has a current yield of 2.83%, a payout ratio of 35.29%, and a 5 year dividend growth rate of 24.57%.
As of the end of September, the company's estimated Tier 1 common equity ratio is 17.6%. This is well above the required minimum of 13.2% set by the Federal Reserve, indicating the company has a strong financial profile.
Management announced a stock buyback program of up to $12 billion of common stock through June 30, 2022.
Is Morgan Stanley A Buy, Sell, or Hold?
Morgan Stanley is the third-largest investment bank behind Goldman Sachs (GS) and JPMorgan Chase (JPM). In terms of revenue, it is the largest wealth management firm in the U.S. MS ranks behind only Goldman Sachs in the equity capital markets.
The acquisitions of E*Trade and Eaton Vance were strategic moves designed to give Morgan Stanley a more balanced and diversified business model. As M&A and IPO activity slows down, or when trading business fades, the firm's wealth and investment management businesses provide a less volatile source of revenues.
Consequently, Morgan Stanley's shift to wealth management from investment banking is a positive move, in my estimation. Investment banking is capital intensive, with returns on equity averaging around 11% over the previous five years. In contrast, wealth management revenue tends to be relatively more stable than investment banking and have high returns on capital.
Upcoming increases in interest rates and asset prices could result in improved revenue and operating margins for the company's asset management and wealth management segments. However, interest rate increases could stunt M&A activity.
While I applaud the recent transformation of the company and view it is an overall sound investment, I do not view the stock's current valuation as providing a margin of safety. With this in mind, I rate MS as a HOLD.
However, I will place this stock on a watch list and may initiate a position should the shares provide a better valuation in the future.
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As of 08/1023 I am rated among the top 3.4% of authors in terms of overall results. This is according to TipRanks, which provides a 64% success rate and an average 16.5% annual return for my articles. (I update this score on at least a quarterly basis for readers.)
I could be characterized as a safety first investor. My primary focus is on dividend bearing stocks. I seek a degree of safety in my investments by concentrating on companies with competitive advantages and strong balance sheets.
I am a also value / buy and hold investor. Since I require a discount in the share valuations of my investments, my ratings are generally very conservative. My valuation requirements, combined with the high quality companies that I often highlight mean many stocks I rate as a hold perform well over the long term. Readers should consider this when weighing my buy/hold/sell recommendations.
I am a retail investor, with no formal training in investing.
I am a graduate of the U.S Army Ranger school and a former member of the 1st Ranger Battalion and The Old Guard (U.S Army Honor Guard.) I am a retired law enforcement officer. I have approximately 20 years experience as a retail investor.
Best of luck in your investments, Chuck
Analyst’s Disclosure: I/we have a beneficial long position in the shares of JPM, GS 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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