Why Rising Equity Indices Could Boost Morgan Stanley's Valuation Even More

Morgan Stanley is among a select group of outperforming investment banks and should profit from its asset management business going forward.

Jul 18, 2014 at 2:50PM

Source: CNBC

Morgan Stanley's (NYSE:MS) Wealth and Investment Management divisions did very well in the second quarter with rising revenues and a sharp uptick in client assets. As long as equity indices keep rising and clients desire to be part of the party, Morgan Stanley should do very well and its equity valuation could see another boost going forward.

With Morgan Stanley delivering its second quarter earnings yesterday, all first-tier, large-cap banking institutions will have reported their financial results for the most recent quarter.

Banks largely chugged along in a mostly unexciting second quarter which highlighted two things: Top line challenges persist, especially for commercial banks, and short-term settlement risk remains.

Pure-play investment bank Morgan Stanley, however, did quite well in the second quarter and the bank remains much less exposed to litigation risk, which so brutally keeps the lid on shares of Bank of America and Citigroup.

Morgan Stanley is among a group of financial companies, that has mastered the financial crisis the best and its valuation reflects higher investor confidence in its business model and earnings prospects.

Revenues are slightly rising, but at least they are rising
Morgan Stanley reported a 1% year-over-year increase in second quarter consolidated earnings to $8.6 billion compared to the $8.5 billion achieved in the second quarter of 2013.

Revenue driver were clearly Morgan Stanley's Wealth Management business, which saw a revenue increase of 5% and its Investment Management business, which hiked its year-over-year revenues by 3%.

A 1% year-over-year increase in revenues doesn't sound like investors would want to throw a party, but put into context, the results are respectable as revenue challenges persist in the financial sector. Goldman Sachs (NYSE:GS), in fact, was the only large-cap bank that could present investors with a mid-single percentage increase of 6% in y-o-y revenues whereas all other major banks reported slight declines in their revenue base.

J.P. Morgan (NYSE:JPM) also reported 3% lower year-over-year revenues of $24.45 billion. Both Goldman Sachs and J.P. Morgan, however, beat analyst expectations on both earnings and revenues -- which is an indicator of generally low analyst expectations with respect to banks heading into earnings season.

Growth in client assets
Besides the good revenue performance of Morgan Stanley's Wealth and Investment Management practices, it is also noteworthy to point out Morgan Stanley's success in attracting client assets.

As one of the largest asset managers in the country, it is paramount for Morgan Stanley to convince high net-worth individuals and institutional investors to fork over their dollars for investment mandates.

And success Morgan Stanley had: Client assets in its Wealth Management division surpassed the $2 trillion mark in the second quarter and rose a whopping 13% year-over-year from $1.78 trillion in the second quarter of fiscal 2013.

Solid growth in Morgan Stanley's book value per share
Morgan Stanley increased its book value per share to $33.48 reflecting a 3% sequential increase over its first quarter book value per share of $32.38 and a 6% increase over last year's book value of $31.48 per share.

Morgan Stanley's tangible book value, which doesn't account for intangible assets such as goodwill and which is perceived as a more robust indicator of its intrinsic value, rose even stronger by 4% sequentially and 9% year-over-year to $28.53 per share.

From a valuation standpoint, I like Morgan Stanley (and Goldman Sachs) better than J.P. Morgan, which is sort of an outlier in the banking peer group with a sizable premium to tangible book value.


In any case, Morgan Stanley's distinguishing Wealth Management practice has been a magnet for funds flowing into the brokerage company and Morgan Stanley can be expected to do reasonably well with its investment management focus as long as equity markets are delivering a good performance.

Rising equity indices and rising fund flows into the investment management business are highly correlated.

Given a sustained bull run in the equity markets, which I think will be the case, Morgan Stanley's core business should receive substantial tailwinds which could further lift Morgan Stanley's equity valuation.

The Foolish Bottom Line
Morgan Stanley is an interesting investment for investors who want to get exposure to a strong Wealth Management and Investment Management practice, that could benefit materially from a buoyant transaction environment.

Morgan Stanley has a solid record in attracting client assets and should continue to see revenue and earnings tailwinds as long as the stock market is doing well and investors are enticed to put their dollars to work with Morgan Stanley.

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