Company Reports

We are increasing our fair value estimate for narrow-moat-rated Morgan Stanley to $97 from $88 per share. This implies a forward price/earnings ratio of about 13 times and a price/tangible book ratio of 2.4 times. Of the $9 increase in our fair value estimate, approximately $2 is from earnings accumulated since our previous valuation update. The remainder is from changes in our earnings forecast, such as from higher investment management revenue after the increase in US equity markets, and some lowering of how much shareholder equity we assess the company will need to retain for regulatory capital requirements.

Morgan Stanley has built a more stable business model, and its shift to wealth management from investment banking will continue to be a main part of the company’s story over the long term. Investment banking is capital intensive, and many banks, especially the European investment banks, have had trouble earning adequate returns in that business and have purposely shrunk that business line. Morgan Stanley has remained dedicated to investment banking and has gained market share. The company had a strong return on equity in its institutional securities business of about 16% in 2020 and 20% in 2021 but has only averaged about 11% over the previous decade.

Morgan Stanley reported strong first-quarter results as the capital markets recovered, and the outlook remains positive. The company reported net income to common shareholders of $3.3 billion, or $2.02 per diluted share, on $15.1 billion of net revenues. The main areas of outperformance were investment banking of $1.6 billion—up 19% from the previous year and 12% from the seasonally strong fourth quarter—and trading with commissions of $6.1 billion, up 6% from the previous year and 38% sequentially. We don't anticipate making a material change to our $88 fair value estimate for narrow-moat Morgan Stanley, and we assess shares as fairly valued.

Investment banking activity is likely to liven up in 2024, but previous growth drivers at Morgan Stanley may not participate. For 2023, Morgan Stanley reported net income to common shareholders of $8.5 billion, or $5.18 per diluted share, on $54 billion of net revenue. Net revenue increased 1% from the previous year as higher trading revenue offset decreases in net interest income and investment banking. We don’t anticipate making a material change to our $88 fair value estimate for narrow-moat-rated Morgan Stanley and assess the shares as fairly valued.

With interest rates at or near their peak and the increasingly popular view that the United States will avoid a recession, investment banking revenue is poised to rebound from recent lows. However, given the record levels of investment banking and trading revenue that U.S.-based banks booked in 2020 and 2021, there's an open question with regard to the reasonable level that investment banking revenue recovers to. While we don't believe that investment banking revenue will reach 2020-21 heights in the foreseeable future, we do believe that U.S.-based investment banks should have consistently higher revenue than they had before the COVID-19 pandemic due to the pullback of Europe-based banks.

We are lowering our fair value estimate for narrow-moat Morgan Stanley to $88 per share from $93. This implies a forward price/earnings ratio of about 13 times and a price/tangible book ratio of 2.2 times. Most of the decrease in our fair value estimate comes from the assumption that the company will have to retain more equity because of proposed bank capital rules, as well as to account for moderately lower forecast investment banking revenue (that was offset somewhat by earnings since our previous valuation update) and other miscellaneous adjustments to our model. While recent Basel III regulatory proposals could increase Morgan Stanley’s risk-weighted assets by about 20%, the banking industry is pushing to have the proposals refined.

Morgan Stanley has built a resilient business model, and we forecast the company having nearly flat revenue and earnings over the next couple of years, despite a still precarious global economic outlook. Institutional securities segment revenue took a fall in 2022 from an abnormally high level in 2021 due to tightening monetary policy and fear of a recession, and falling asset prices put a dent in asset management revenue. These negatives were somewhat offset by growth in high profitability net interest income in the wealth management segment. With quite a bit of negativity already reflected in results, we don’t anticipate another significant decline in revenue. However, we also don’t anticipate a maintained recovery in capital markets activity and asset prices until the recession question is resolved.

Narrow-moat-rated Morgan Stanley reported fairly stable results for the third quarter, and the company's outlook is still stable to positive for most revenue lines. Morgan Stanley reported net income to common shareholders of $2.26 billion, or $1.38 per diluted share, on $13.27 billion of net revenue. Net revenue was down 1% from the previous quarter, and year-to-date net revenue was 1% higher than the first nine months of 2022. While investment banking management teams had alluded to "green shoots" the previous quarter, investment banking revenue decreased 9% sequentially, mainly due to lower fixed-income underwriting. More recently there have been some high-profile IPOs, but it often takes time for underwriting like this, as well as merger deals, to close. Morgan Stanley and other investment banks should have much better investment banking results in 2024, assuming a "soft landing" is achieved in the economy. We don’t anticipate making a material change to our $93 per share fair value estimate for Morgan Stanley and assess shares as being moderately undervalued.

Morgan Stanley has built a resilient business model, and we forecast the company having nearly flat revenue and earnings over the next couple of years, despite a still precarious global economic outlook. Institutional securities segment revenue took a fall in 2022 from an abnormally high level in 2021 due to tightening monetary policy and fear of a recession, and falling asset prices put a dent in asset management revenue. These negatives were somewhat offset by growth in high profitability net interest income in the wealth management segment. With quite a bit of negativity already reflected in results, we don’t anticipate another significant decline in revenue. However, we also don’t anticipate a maintained recovery in capital markets activity and asset prices until the recession question is resolved.

Morgan Stanley's net revenue has been range-bound over the previous year, but the increasing probability of a soft landing and recent capital markets activity give us cautious optimism on earnings bottoming. Morgan Stanley reported net income to common shareholders of $2.05 billion, or $1.24 per diluted share, on $13.46 billion of net revenue. Net revenue decreased 7% from the previous quarter, which had benefited from strong trading results, and increased 2% from the previous year. We don't anticipate making a material change to our $91 fair value estimate for narrow moat-rated Morgan Stanley and assess that shares are fairly valued.

The Federal Reserve has released the results of its annual stress tests. Our key takeaway is that the banking system remains well capitalized, and stress capital buffers, or SCBs, are likely to be declining for nearly half of the banks we cover who participated in the test this year. This will bring some capital relief to some key names under our coverage, including JPMorgan, Bank of America, M&T Bank, Goldman Sachs, and Morgan Stanley. Whether or not management teams will actually lower their internal common equity Tier 1 targets is another story. As they await other potential regulatory changes, we expect most would choose to err on the side of holding more capital rather than less. Even so, we would view these banks as the big winners from this year’s stress tests as results are set to give these banks more buffer space for now.

We are maintaining our $91 fair value estimate for narrow-moat-rated Morgan Stanley after James Gorman announced he will be stepping down as CEO in the next year. Gorman created significant value for Morgan Stanley shareholders; he was instrumental in transforming the firm into a more balanced financial institution with significant investment-management operations from an investment bank that was on shaky ground in the global financial crisis. Wealth and asset management have recently contributed about 55% of net revenue compared with closer to 40% before the financial crisis, and these businesses will likely be material drivers of the company’s long-term growth. While Morgan Stanley’s investment-management business has grown as a proportion of net revenue, the investment bank has continued to thrive with high league table rankings for underwriting and merger advisory and growth in trading market share.

The cyclical nature of some of Morgan Stanley’s revenue and potentially abnormally high trading revenue mean that revenue growth in 2023 is far from certain. Morgan Stanley reported net income to common shareholders of $2.8 billion, or $1.70 per diluted share, on $14.5 billion of net revenue. Net revenue only decreased 2% from the previous year and sequentially increased 14%. The main contributor to the relatively good revenue performance was trading revenue that increased 6% from the previous year and sequentially increased 37% to $5.7 billion. While the uncertain macroeconomic environment has kept investment banking revenue low—a 24% decline from the previous year and over 50% decline from the 2021 quarterly average—it has helped trading revenue. That said, trading revenue is volatile and it’s one of the only revenue lines that has held up well and is arguably abnormally high, so it can’t be counted on to offset economic pressures in other revenue lines. We don’t anticipate making a material change to our $91 fair value estimate for narrow-moat Morgan Stanley and assess shares are fairly valued.

Morgan Stanley has built a resilient business model, and we forecast the company having nearly flat revenue and earnings over the next couple of years, despite a precarious global economic outlook. Institutional securities segment revenue took a fall in 2022 from an abnormally high level in 2021 due to tightening monetary policy and fear of a recession, and falling asset prices put a dent in asset management revenue. These negatives were somewhat offset by growth in high profitability net interest income in the wealth management segment. With quite a bit of negativity already reflected in results, we don’t anticipate another significant decline in revenue. However, we also don’t anticipate a strong recovery in capital markets activity and asset prices until the recession question is resolved.

Most of the issues that affected Silicon Valley Bank don’t apply to the wealth management firms and investment banks that we cover, so we don’t plan to make material changes to our fair value estimates or Morningstar Economic Moat Ratings for Morgan Stanley, Goldman Sachs, Ameriprise Financial, Raymond James Financial, LPL Financial, Stifel Financial, Evercore Group, or Lazard.

Most of the drop in Morgan Stanley’s 2022 revenue and earnings can be attributed to capital markets, and while the economy should be on the edge of a recession in 2023, the year may also establish a bottom for capital markets activity and asset prices for this cycle. For the fourth quarter of 2022, Morgan Stanley reported net income to common shareholders of $2.1 billion, or $1.26 per diluted share, on $12.7 billion of net revenue. Net revenue declined 12% from the previous year and 2% sequentially, leading to 41% and 15% declines in net income, respectively. The majority of the year-over-year revenue decline came from the institutional securities business. As we had said in 2021 and 2022, the institutional securities business had abnormally high investment banking and trading revenue related to the monetary and fiscal stimulus used to combat the economic effects of COVID-19. We had also mentioned that 2021 institutional securities operating margins were much too high at about 40% compared with a recent historical average closer to 30% and that Morgan Stanley and other capital market firms could have declining revenue and compression in operating margins. For the whole year, institutional securities segment net revenue declined $5.4 billion, or 18%, and operating margins compressed to 28% from 40%. We don’t anticipate making a material change to our $91 fair value estimate for narrow-moat Morgan Stanley and assess shares are fairly valued.

We are decreasing our fair value estimate for narrow-moat-rated Morgan Stanley to $91 from $96 per share. This implies a forward price/earnings ratio of about 13.5 times and a price/tangible book ratio of 2.3 times. Of the net $5 decrease in our fair value estimate, $2 was from the recent decline in client assets, $2 is from lower investment banking and trading revenue, and $1 is from miscellaneous changes in our model.

Morgan Stanley had exceptionally strong 2020 and 2021 investment banking and trading results as the economy started to reopen from COVID-19. Morgan Stanley also acquired discount brokerage E-Trade and asset manager Eaton Vance that boosted revenue in 2021. While Morgan Stanley will harvest synergies from recent acquisitions and is exposed to positive tailwinds, such as higher interest rates, we forecast net revenue taking a moderate step down from $52 billion in 2021 to about $45 billion and staying around there for several years, as economic uncertainties stifle investment-banking revenue and client assets take time to recover from the bear market.

As expected, Morgan Stanley’s overall third-quarter financial results were significantly lower than those of the prior two years, which were unusually strong, but the company was still fairly profitable, and results may start to stabilize. The company reported net income to common shareholders of $2.5 billion, or $1.47 per diluted share, on $13 billion of net revenue. Net revenue fell 12% from the previous year with earnings per share falling 30%, but net revenue only declined 1% sequentially with a 4% increase in earnings. We don’t anticipate making a material change to our $96 fair value estimate for the narrow-moat firm and assess the shares as moderately undervalued.

Many investment service firms (wealth managers, retail brokerages, custody banks, and asset managers) have material exposure to interest rates. Clients at wealth management firms and retail brokerages typically have 5%-20% of their account balance in cash that the financial institution sweeps into a bank subsidiary. The deposits are then used to make loans or invest in fixed-income securities. They may also earn asset management or distribution fees on client assets in money market funds.