Morgan Stanley (MS 0.20%), one of the top financial services firms in the world has been doing quite well lately. Aside from a decline in fixed-income revenues, which affected the entire industry, the company has performed commendably so far in 2014.
Despite the growing revenues and lower litigation expenses and other overhead, Morgan Stanley is still trading relatively cheaply. Is now a good time to buy in to this investment banking leader?
The strong IPO and M&A market is boosting revenue
Thanks to the strong market and low interest rate environment, IPO and mergers and acquisitions activity has been on fire lately, and it doesn't appear to be letting up.
Morgan Stanley's advisory and underwriting revenue experienced incredible year-over-year growth, as revealed in the company's second-quarter earnings release. Advisory revenue grew by 25% and equity underwriting revenue soared by nearly 50%. Fixed-income underwriting revenue also increased by about 20%, not surprising considering the low interest rates companies have to pay on newly issued debt right now. It's safe to say that Morgan Stanley's institutional securities division is firing on all cylinders.
Morgan Stanley Advisory and Underwriting Revenue Growth | Create Infographics
This year has already been a strong year for IPOs with major companies like GoPro and El Pollo Loco going public and the upcoming Alibaba Group IPO is likely to be the largest in history. And, Morgan Stanley CFO Ruth Porat recently said at an investors' conference that both M&A and underwriting activity remains strong in the third quarter.
Wealth management is growing in the right way
Let's face it: it is easy to grow a wealth management business when the market is hitting new highs seemingly every other week. If you manage $1 billion in assets and the value of those assets rises by 10%, you now manage $1.1 billion in assets.
A better measure of how the business is growing is to look at the inflow (or outflow) of money from client accounts. If more money is being deposited than being withdrawn, the business is growing regardless of what the market is doing.
In Morgan Stanley's case, client assets in fee-based accounts rose by 21% year over year to $762 billion. Well, over the same time period, the S&P 500 increased by more than 19%, so this isn't terribly impressive on its own. However, the fact that $12.5 billion in net deposits flowed into client accounts tells us that Morgan Stanley's wealth management business is healthy and growing in the right way.
Legal expenses are (mostly) in the past
One of the main reasons the banking sector is still trading at historically low valuations several years after the financial crisis is the uncertainty of litigation expenses.
For example, Bank of America and JPMorgan Chase have both agreed to eleven-figure settlements with the FHFA involving the sale of mortgage-backed securities. And Goldman Sachs, perhaps the best apples-to-apples comparison to Morgan Stanley recently agreed to a settlement that will effectively cost the firm about $1.2 billion.
Well, Morgan Stanley also settled with the FHFA for $1.25 billion in February and just recently announced another $95 million settlement for additional mortgage-backed securities allegations.
And while there is an ongoing possibility of additional legal settlements, it is an expense the company and its shareholders are relieved to pay. Every time Morgan Stanley settles a financial-crisis related claim, the firm is one step closer to putting the crisis firmly in the past.
Low-risk, high-potential reward
As I alluded to earlier, Morgan Stanley trades at a pretty low valuation, both relative to its historical valuation level and relative to the value of its assets.
Morgan Stanley is trading for just over its book value, which is much higher than the fire-sale valuations seen in the years immediately following the crisis, but much lower than the company's historical price-to-book. And while the P/B multiples of above two during the peak bubble years were probably inflated, during more stable times the company's price-to-book has hovered around 1.75.
Basically, because of the low valuation relative to its assets, Morgan Stanley has a lot more upside potential than it does downside risk. With the majority of the litigation expenses covered and the thriving business, it's hard to make the case that Morgan Stanley should trade below book value anytime soon.
Is it time to buy?
Bear in mind that nothing is certain here. It's entirely possible for the U.S. economy to turn sour again and take a lot of Morgan Stanley's profit with it.
However, the improvement in the company's business and the cheap valuation makes Morgan Stanley's stock look like a solid buy from a risk-to-reward position.
