While Morgan Stanley (MS 3.64%) has performed well lately despite an uncertain economy, investors aren't giving it enough credit for the moves it's made to succeed in any climate. The company has made strategic acquisitions this year to diversify its revenue streams -- becoming less reliant on traditional investment banking, which can be very volatile .
In the past 10 months, the company acquired asset management firm Eaton Vance (EV) and E*Trade, known for its electronic trading platform, for a total of $20 billion. However, the company currently sports a price-to-earnings ratio below industry peers. Even Morgan Stanley CEO James Gorman recently questioned the company's valuation.
Morgan Stanley has made a big splash with its acquisitions this year and hopes to grow and diversify its business and has posted solid earnings results, but it's taken the market's huge rally the past few days to get the stock into positive territory. That prompts the question: Is Morgan Stanley a great value stock right now?
Growing in a tough economic environment
Despite a murky economic environment this year, Morgan Stanley has showed steady growth, which was exceptionally strong in the third quarter.
The company posted revenue of $11.7 billion for growth of 16% compared with the same quarter last year, and net income of $2.7 billion, an increase of 25% compared with the same quarter last year. The institutional securities segment -- which relies on investment trading for income -- drove revenue higher in the quarter, increasing 21% compared to the same quarter last year. This segment alone accounted for $6.1 billion in total revenue, or 52% of the company's revenue during the quarter.
While trading drove revenue in this first quarter, Morgan Stanley knew it needed a more diversified revenue stream that could perform in all types of market environments. That's why acquiring E*Trade and Eaton Vance was a match made in heaven.
Acquisitions should drive further growth
Morgan Stanley spent big money on acquisitions this year -- first on the purchase E*Trade, which officially closed on Oct. 2 for $13 billion, and then on Eaton Vance, which was recently announced on Oct. 7 for another $7 billion. These acquisitions were driven by the company's goal to become more than an investment bank.
With the acquisitions of Eaton Vance and E*Trade, Morgan Stanley projects that 58% of its pre-tax profits will come from wealth and asset management on a pro forma basis. To put this in perspective, in 2019 51% of pre-tax profits were generated from wealth and asset management; that itself is a long way from 2010, when 26% of its pre-tax profits were from this same segment.
In the most recent quarter, which didn't include financials for either of these acquisitions, Morgan Stanley got $1 billion in revenue from its investment management segment. Total assets under management (AUM) during the quarter reached $715 billion. With the acquisition of Eaton Vance, the company expects AUM to grow to $1.2 trillion, which projects to bring in $5 billion in revenue annually.
The purchase of E*Trade boosts total client assets to $3.5 trillion while helping the company fill some gaps and offer complimentary services through its electronic trading platform. According to Gorman, the E*Trade acquisition "provides more balance to our business model. It's more wealth management revenue, it's more stability, it's less volatile than the core markets business."
Is the current valuation warranted?
Morgan Stanley investors don't seem to be as impressed with the moves the company has made, judging by its current valuation. The investment bank is trading around a price to earnings ratio (P/E) of 9 as of Wednesday morning, while competitors like Charles Schwab and Goldman Sachs are trading at 21 and 12 times earnings, respectively.
Investment banks tend to trade at lower multiples because of their reliance heavily on higher trading volume and growth in underwriting deals, which can be very volatile. This is a big reason why Morgan Stanley felt the need to acquire E*Trade and Eaton Vance -- so it wouldn't be so dependent on those traditional investment banking revenue streams.
Even though Morgan Stanley created a business that has $4.4 trillion of assets under management through asset management and wealth management, Gorman questioned the stock price a month ago in the call announcing the Eaton Vance deal -- noting that its competitor Charles Schwab was trading at "something like 20 times earnings ... and we're trading at 10 times earnings. ... It makes absolutely no sense."
Morgan Stanley -- A great value investment
In my opinion Morgan Stanley is a great value right now. The acquisitions made this year will increase its wealth and asset management segments and will diversify future revenue streams for the company.
With a price-to-earnings ratio around 9, currently on the low end in its industry and not far from the lowest it's been since 2012, investors may find that now is the time to buy Morgan Stanley.