In January, Morgan Stanley (NYSE:MS) emerged as a clear winner among the biggest banks as it posted impressive Q4 results. In contrast, a number of banks reported huge earnings misses, like Goldman Sachs (NYSE:GS). Morgan Stanley’s outperformance was attributed to stable revenues and margins from its growing Wealth Management (WM) business. While I’m bullish on the WM segment’s growth potential and expect it to grow in the coming years, I believe the growth is already factored into the current share price. Given its expensive valuation, I will wait for a better entry point to buy MS stock.
Since the subprime crisis of 2008, Morgan Stanley bank has emerged much stronger. Under the leadership of CEO John Gorman, the bank has efficiently diversified across three growing divisions: Wealth Management, Investment Management, and Institutional Securities.
Diversification into fee-based and capital-light businesses away from the traditional investment banking model has not only boosted revenues and profits but has significantly reduced volatility for the bank. It clearly helped the bank have a smoother ride versus peers in 2022, as evident from the chart below.
Likewise, on January 17, the company reported upbeat Q4 results beating both top-line and bottom-line estimates. CEO James P. Gorman stated, “Wealth Management provided stability with record revenues and over $310 billion in net new assets, Investment Management benefited from diversification, and within Institutional Securities our Equity and Fixed Income revenues were strong, offset by Investment Banking.”
Wealth Management: Long-Term Growth Driver for Morgan Stanley
The Wealth Management business was one of the key contributors to MS’ earnings beat during Q4. Over the last decade, the bank has slowly and steadily bolstered its less-capital-intensive Wealth Management Business to its current stature.
Meaningful acquisitions of E*Trade and Eaton Vance further amplified the segment growth. Client assets and revenues have grown on a consistent basis, exhibiting a superior performance compared to the Investment Banking segment. In fact, in 2022, the combined Wealth and Investment Management segment contributed 52% to total revenues at Morgan Stanley. This is a huge shift from about 26% of total revenues in 2010.
Notably, the bank has made lofty goals and continues to transform its business shift towards Wealth Management. It plans to increase its client assets in Wealth Management to $10 trillion in the long term. As of the end of 2022, client assets stood at $5.5 trillion.
In fact, during the earnings call, CEO James Gordon stated that “over a three-year period, we expect to drive approximately $1 trillion in net new assets.” Justifying the high-end goals, management highlighted that the business has been able to generate net new assets of approximately $300 billion each year over the last three years.
Gorman predicts — assuming the client assets grow in line with expectations — that MS will be able to generate a pre-tax profit of $14 billion just from its Wealth and Investment Management business (at an assumed 30% pre-tax margin).
This will be huge, given that the bank reported a total pre-tax profit of $14 billion in 2022. Improved revenues from other segments (Investment Banking and Trading Revenue) will further add to overall revenues and profitability.
Strong Returns Via Dividends & Buybacks
The company delivered an impressive return of 9% to shareholders in 2022 in the form of dividends (3%) and share buybacks (6%, worth $10 billion). This is commendable, given the tough macro environment.
In fact, its dividends have more than doubled from $0.35 per share in FY2020 to $0.775 paid during Q4 2022. The current dividend implies an annual dividend yield of 3.2% which is superior to the financial sector average of 2.1%.
It’s worth noting that despite the handsome returns to investors in 2022, the company still has 200bps of excess capital or capital buffer on its balance sheet. This means that the company could return increased dividends and resort to higher buybacks in the coming years, thereby creating more shareholder value.
Morgan Stanley Stock is Relatively Expensive
In terms of its valuation, Morgan Stanley is trading at one of the biggest premiums compared to its peer group. Nonetheless, the premium is justified given its favorable “excess capital” position compared to peers. Its Investment and Wealth Management business is not capital-demanding and has a fee-based revenue model. This leads to a sturdier capital structure for MS.
At present, the company is trading at a price/book ratio of 1.8x, much higher than the peer group average of 1.2x. However, the premium is also justified in terms of returns provided by the banks. Goldman’s return on tangible equity (ROTE) fell to 4.8% during the recently reported fourth quarter compared to the 12.6% reported by Morgan Stanley in the same period.
Is Morgan Stanley a Good Stock to Buy Now?
Turning to Wall Street, analysts are cautiously optimistic about Morgan Stanley stock and have a Moderate Buy consensus rating, which is based on nine Buys, seven Holds, and two Sells. Morgan Stanley stock’s average price forecast of $99.99 implies 3.6% upside potential.
Conclusion: Wait for a Better Entry Point
Morgan Stanley has been a top-notch performer in the banking space recently. Impressive returns (an ROTCE of 15.3% in 2022) and relatively good margins from diversified businesses are commendable. A strong balance sheet with limited credit exposure as well as excess capital is the cherry on the cake.
However, given its lofty valuation, I don’t see significant expansion in the share price from current levels. I believe in the long-term growth potential of the bank but will wait for a better entry point to capture better returns.
