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Since the Financial Crisis, Banks Have Cut Balance-Sheet Risk - What Is Expected for the Future?
Posted by: Damian Illia (IP Logged)
Date: November 22, 2013 05:21PM

In the last two articles, we analyze four banks and saw that they are doing pretty well. U.S. bank stocks have revalued during the past years. This is not a surprise because bank stocks tend to outperform in periods of declining rates and easing monetary policy like the environment we are having now. The Federal Reserve's decision to postpone tapering and Bernanke´s opinion that the Fed will probably hold down its target interest rate long after ending $85 billion in monthly bond buying, create a good outlook for banks with historically low valuations but better financials. So let's take a look at two more banks and see which one is doing better and thus stands as the best investment.

Redefining the Meaning of Financial Services

Morgan Stanley (MS) is among the largest financial services firms in the U.S., with operations divided into 3 segments: wealth management, Institutional Securities and investment banking. Each unit has unique business drivers so we are going to analyze them separately.

Several Times Larger

A key driver of the company will be its Global Wealth Management Group (GWMG) business, which is now wholly owned, after the acquisition of the remaining 35% stake for nearly $5 billion. This unit accounted for 52% of total revenues in 2012, up from 31% in 2007. In institutional securities (40% of 2012 revenues), relevant aspects are Basel III rules with capital and other regulatory changes; and the proposed higher supplementary leverage ratio. Morgan Stanley's 4.2% leverage ratio is at the lower end of peer group which is an advantage. Finally, the investment banking unit, which accounted 8% of 2012 revenues, is still below its peers, but we think it would increase due to a good performance in the other key areas of the bank.


In terms of valuation, the stock sells at a trailing P/E of 18.9x, trading at a discount compared to an average of 20.4x for the industry. Analysts’ expectations imply a forward P/E of 12.12. To use another metric, its price-to-book ratio of 0.9x indicates a discount versus the industry average of 1.2x and the price-to-sales ratio of 1.9x is below the industry average of 2.63x.

This One Is Also Attractive

The Goldman Sachs Group, Inc. (GS) is one of the world's leading investment banking and securities companies.

Good Financials

Since the financial crisis, the bank has cut balance-sheet risk by increasing capital. So the rising excess capital will not be a major problem and allows for higher shareholder returns through dividends and share buybacks. Management ability to cost cutting should improve profitability as well as its business diversification.

Its P/E multiple on a trailing 12-month basis is 10 and the forward P/E multiple is 10.69. We can appreciate that both banks carry discounts to the industry average of 20.4x P/E. These valuations might attract investors. Bank´s dividend yields are below the historic average, and Goldman Sachs is not an exception. The current dividend yield is 1.21%, which is not enough to protect the purchasing power.

Finally, I always like to see of one of the most important financial ratios applying to stockholders, the best measure of performance for a firm's management: the return on equity

Bank ROE Compared to Industry Mean (=4.7)
Morgan Stanley 0.1 Below
Goldman Sachs 9.9 Above

While Goldman Sachs ROE of 9.9% is above the capital market industry mean of 4.7%, Morgan Stanley's low ROE is not attractive at all. It is very important to understand this metric before investing in a high-growing company. The following graph shows the evolution of the ratio in the last 10 years. It can be seen that the ratio remains higher in the case of Goldman Sachs.

Final Comment

Monetary policy may begin to taper sometime, creating risk to U.S. growth, which is extremely negative for banks. Also, new regulation on higher capital requirements could affect the bank´s profitability. On the other side, key revenues drivers analyzed before makes me think that Morgan Stanley is a more attractive option for investors.

Hedge fund gurus like Jim Simmons, John Keeley, Jeremy Grantham, Ken Heebner and Mario Gabelli added Morgan Stanley stock to their portfolios. Should you too?

Disclosure: Damian Illia holds no position in any stocks mentioned.

Guru Discussed: Jeremy Grantham: Current Portfolio, Stock Picks
John Keeley: Current Portfolio, Stock Picks
Stocks Discussed: MS, GS,
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