Morgan Stanley’s (MS, Financial) valuation is still too low, in my opinion. Shares are up 7% since I highlighted the stock for its low valuation and high yield earlier this month.
Morgan Stanley has returned more than 16% over the last year compared to a return of less than 9% for the S&P 500. The company’s business is performing well, and I think it is still poised to offer double-digit returns from the current share price.
Quarterly highlights
Morgan Stanley reported its second quarter earnings results on July 16, and it outperformed Wall Street’s expectations.
Net revenues increased almost 31% to $13.4 billion, $3 billion higher than expected. Earnings per share increased by 73 cents, or 59.3%, to $1.96. This was 85 cents higher than expected. Morgan Stanley’s EPS results were the best of the big six top U.S. banks, and the company was just one of two names in that elite group to show year-over-year revenue growth.
Morgan Stanley accomplished top and bottom-line growth through contributions from almost all of its business segments.
Far and away the best performing segment was Institutional Securities. This segment, representing just under 60% of total revenues, grew 56% from Q2 2019 and 63% from Q1 2020 to $8 billion. The sales and trading business were the primary drivers of growth, with revenues improving 68%. Client trading was especially strong as the markets began to stabilize in the second quarter. Within this business, fixed income revenues soared to $3 billion from $1.1 billion in the second quarter of 2019. Performance across all products and geographies as well as robust activity in global capital markets were the catalysts for this improvement.
In addition, investment banking improved 39%, as equity underwriting and fixed income revenues increased 62% and 68%, respectively. Equity underwriting saw increased volumes while fixed income benefited from higher investment grade and non-investment grade bond issuances. This offset a 9% decline in advisory revenues.
The Wealth Management segment, which contributed 35% of total revenues, grew 6.2% year-over-year to $4.7 billion. Revenues improved nearly 16% from the first quarter of 2020. While asset management revenues were essentially flat on account of lower market and average fee rates, transactional revenue improved 48% from the previous year.
Investment Management, which made up the remainder of the company’s revenues, improved 5.6% from the previous year and28% from the first quarter of the year to $886 million. This segment benefited from a record net flows of $15.4 billion. Morgan Stanley had $665 billion in assets under management at the end of the quarter, which was also a new record.
Morgan Stanley had a solid quarter. While the headline numbers were especially impressive compared to the previous year, the company’s Institutional Securities segment provided much of the year-over-year growth. This isn’t to say that Morgan Stanley’s other businesses were weak, they simply weren’t performing at the same level as this segment
Valuation analysis and potential returns
Morgan Stanley closed Wednesday’s trading session at $51. Wall Street analysts expect the company to earn $4.60 per share in 2020. This is up from $3.75 of EPS that was expected prior to the most recent quarterly report.
Based off of revised guidance, shares of Morgan Stanley trade with a forward price-earnings ratio of 11.1. The stock has traded with an average multiple of 12.4 times earnings since 2010. For context, the S&P 500 trades with an average price-earnings ratio of more than 28. Morgan Stanley trades below its usual valuation and at a steep discount to that of the market index.
I have a price-earnings ratio target range of 12 to 14 for shares of Morgan Stanley. Excellent performance in Institutional Securities and solid results from its other business segments warrants the higher earnings multiple in my opinion.
Applying expected EPS to this target range results in a share price of $55 to $64. By these estimates, Morgan Stanley could return between 8% and 25% based off of the most recent closing price.
Of course, the company’s dividend would also factor into returns. The current dividend of $1.40 would add an additional 2.2% to 2.5% to returns using my price target range.
Altogether, shares of Morgan Stanley offer high potential.
Final thoughts
Of all the large financial institutions, Morgan Stanley had one of the best reports. The company delivered a revenue and EPS beat well beyond what the market had anticipated. Each of the company’s business segments also improved compared to the previous year.
At the same time, the stock trades with a valuation that I think is incredibly cheap despite the most recent earnings report and a sizeable increase in expected EPS for the year.
Author disclosure: the author has no position in any stocks mentioned in this article.
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