Bank Stocks: Watch the Falling Ax

On Monday, the Financial Times reported that Morgan Stanley (NYSE: MS  ) is in the process of pruning 100 staff from its sales and trading activity. At the beginning of 2010, CEO James Gorman pledged to bring the compensation-to-revenue ratio down, with a target of 50%. With the bank cutting staff in the run-up to its earnings announcement on July 19, it's hardly an encouraging indicator for expected revenue or earnings.

Despite this, Morgan Stanley's second-quarter earnings estimates have come down less than those of its peers:

Company

% Change Last Month, Q2 EPS Estimate

% Change Last 3 Months, Q2 EPS Estimate

Goldman Sachs (NYSE: GS  ) (34%) (41%)
JPMorgan Chase (NYSE: JPM  ) (13%) (38%)
Bank of America (NYSE: BAC  ) (7%) (7%)
Citigroup (NYSE: C  ) (4%) (8%)
Morgan Stanley (4%) (6%)

Source: S&P Capital IQ.

Across the sector, the trend is clear: The environment has deteriorated. Economic growth is down, uncertainty is up, and that's taken its toll on the levels of M&A activity and client trading, which fuel investment bank revenues.

Morgan Stanley isn't worst off
Did Morgan Stanley's businesses outperform rivals' in the second quarter? Perhaps, but I can't help but think the numbers will disappoint once they are in. Still, the second quarter is in the bag and stock prices are forward-looking; on that basis, it is Bank of America shares that look most vulnerable to downward guidance by management for the rest of the year's results.

Indeed, while analysts have reduced estimates for second-quarter earnings per share by 7% over the past three months, the estimate for full-year 2012 EPS has risen 2% over the same period! Full-year EPS estimates have fallen at every other "top five" bank, ranging from a 3% decline for Citigroup to 8% for Goldman Sachs. Combine that with the fact that B of A trades on the highest price-to-earnings multiple in the group and you have the potential for some earnings announcement volatility -- and not the right kind. Whether it is personnel or earnings guidance, bank stock investors would do well to watch the falling ax.

To learn more about the most-talked-about bank out there, check out our in-depth company report on Bank of America. The report details Bank of America's prospects, including three reasons to buy and three reasons to sell. Just click here to get access.

Fool contributor Alex Dumortier holds no position in any company mentioned. Click here to see his holdings and a short bio; you can follow him on LinkedIn. The Motley Fool owns shares of Citigroup, Bank of America, and JPMorgan Chase. Motley Fool newsletter services have recommended buying shares of Goldman Sachs Group. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


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