Unlike traditional commercial bank stocks, which were hit hard by the coronavirus pandemic, investment banks have fared much better. While mergers and acquisitions activity has lagged, investment banks more than picked up the slack with increased underwriting for initial public offerings and higher sales and trading activity.

Morgan Stanley (NYSE:MS) has produced the biggest gains of the major U.S. investment banks, with its stock up almost 26% year to date. Let's take a look at what's behind the performance.

A rerating of the stock

Morgan Stanley managed to engineer not one, but two massive acquisitions in 2020 that will leave it looking like a much different company. In February, Morgan Stanley acquired the electronic brokerage firm E*Trade. The bank moved again in October, snapping up the asset management firm Eaton Vance. In total, the two deals cost Morgan Stanley about $20 billion, but they already seem to be paying off.

Generic bank facade

Image source: Getty Images.

The main thing these two acquisitions accomplish is helping to diversify Morgan Stanley's revenue mix. Morgan Stanley has always been a top investment bank. In 2010, 74% of the bank's total revenue came from its institutional securities business, and 26% from wealth and asset management. Following the two acquisitions, if you look at the bank on a pro forma basis based on 2019 numbers, 58% of total revenue would have come from wealth and asset management, and 42% from the institutional securities division. With wealth and asset management companies considered a more low-risk revenue source, investors seem to value them more than investment banks.

Now, Morgan Stanley CEO James Gorman believes investors should view and value the company differently. Following the acquisition of Eaton Vance, Gorman told analysts on a conference call that he thought the bank should trade at 14 or 15 times earnings, closer to competitor Charles Schwab. At 14 or 15 times earnings, Gorman said, Morgan Stanley would trade for $100. When Gorman said this, Morgan traded for less than $51 per share. At Wednesday's close, the company traded for $64.23. "There will be a rerating of this stock. I hope it happens in my career, let alone in my lifetime. I know it's happening now," said Gorman.

You can see just how much investors value what Morgan Stanley has done when you compare it to Goldman Sachs, arguably the country's most prestigious investment bank. Goldman generated record earnings in the third quarter of the year and also had incredibly strong performance in the second quarter. It has also been working on diversifying its revenue mix. Yet the company's stock is only up about 6% year to date.

More to come

Morgan Stanley hasn't traded at these levels since the Great Recession. Additionally, in October, the rating agency Moody's upgraded Morgan Stanley's credit rating to A2. Not only does that mean that Moody's views the company as a low risk, but Morgan Stanley was also the only global systemically important bank to receive an upgrade during the coronavirus pandemic. Morgan Stanley should be able to find more revenue synergies with the E*Trade and Eaton Vance acquisitions, and keep the momentum going in 2021.