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If Morgan Stanley’s activities can collapse that quickly, as they did during the fourth-quarter of 2018 when the market swooned, it really calls into question the durability of the earnings stream for all of the global players.
By Matthew Warren
Morgan Stanley (MS) reported first-quarter 2019 results April 17 with net revenues down 7%, earnings down 9%, and diluted earnings per share down 4%. Return on equity was 13.1% versus 14.9% last year. The firm’s efficiency ratio was 71% versus 69% in last year’s first quarter. The bank is well-capitalized with a common equity Tier 1 ratio of 16.5%, which is necessary considering the riskier nature of Morgan Stanley’s balance sheet compared to a universal bank like JP Morgan (JPM). While results were down from last year, they were a substantial improvement over the abysmal fourth quarter.
That’s the rub though; last quarter is very recent evidence that Morgan Stanley is unlikely to earn above the cost of capital through the entire cycle. Morgan Stanley is a mixed bag. The wealth management unit is the crown jewel. It is a scale business, and Morgan Stanley certainly benefits from this scale. The bank has a critical mass of advisers covering the country, and all of this activity rests on a platform of both technology and processes. This drives cost competitiveness, and also therefore revenue opportunities. While the investment business isn’t the largest in the world, it is certainly large enough, and we suspect the economics are good. It also enjoys synergies with the wealth business.
It is the institutional securities business that is overtraded globally and highly cyclical, dependent on market levels and activities. If you think about it, the fourth quarter of 2018 was only a hiccup after a huge run up in market levels. If Morgan Stanley’s activities can collapse that quickly, it really calls into question the durability of the earnings stream for all of the global players. The extensive industry capacity is there whether the client activities are or not. When activity dries up, earnings and returns on capital head south in a hurry. We’re simply not big fans of investment banking and trading businesses, no matter how they are labeled by a particular bank, or even how high a firm sits in the ranking tables. We are maintaining our $50 fair value estimate.
Related: XLF, KBE, KRE
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Matthew Warren does not own shares in any of the securities mentioned above. Some of the companies written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.