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NEW YORK (
Morgan Stanley(MS - Get Report) has spent over a generation on Wall Street playing the dumb cousin to
Goldman Sachs(GS - Get Report), but now it may finally be paying off.
The bank's stronger-than-expected
second quarter earnings still
pale in comparison to Goldman's. However, signs of improvement in Morgan Stanley's less-heralded brokerage and wealth management businesses are convincing investors to pay up for its shares.
Currently, Morgan Stanley commands about a $54.5 billion market capitalization: roughly 70% of Goldman's $78 billion market cap. But the bank led by Australian-born James Gorman is forecast by analysts to be only about half as profitable as Goldman Sachs. Also, Morgan Stanley is only expected to earn 13% the earnings per share (EPS) of its larger rival, according to estimates compiled by
Analysts currently project Morgan Stanley will earn $2 in EPS in 2013, versus over $15 in EPS for Goldman Sachs, the data show.
So why are investors attaching a seemingly high premium to the earnings of Morgan Stanley and discounting those versus Goldman Sachs?
Ironically, much of the premium may be explained by the declining influence of Morgan Stanley on Wall Street, although it remains the second largest standalone investment bank in the world.
Morgan Stanley's management ranks were roiled in the credit-fueled bull market run of the 2000s, as it lost Wall Street market share to competitors such as
Lehman Brothers and, most notably, Goldman. Still, in the ensuing Wall Street collapse, the bank found itself illiquid, overleveraged, holding toxic mortgage debts and on the precipice of failure.
To survive, Morgan Stanley sold a 22.4% stake in the bank to Japan's
Mitsubishi UFJ. Goldman, while also on the brink of collapse, was able to use stock issuance and a preferred share investment made by Warren Buffett to make it through the crisis. [Both Morgan Stanley and Goldman Sachs also were bailed out by the U.S. Treasury].
In the wake of Wall Street's bailout, the bank was again in a position of weakness relative to Goldman Sachs. While Goldman quickly rebounded from the crisis to post record profits, Morgan Stanley's earnings lagged.
Morgan Stanley and its CEO James Gorman also took the financial crisis as reason to move away from the riskier businesses that had gotten the bank in trouble. In late 2008, the firm entered a joint venture to take control of brokerage
Smith Barney from
Citigroup(C - Get Report). Now Morgan Stanley has
full control of the JV, and it is closing in on Bank of America Merrill Lynch for the industry's top spot.
Investors are increasingly interested in the Morgan Stanley's brokerage and wealth management business, even if the firm will continue to have a leading investment bank.
As pre-tax margins at Morgan Stanley's brokerage unit close in on an initial target of 20%, the bank's shares have performed strongly. In the past three quarters, the unit has turned from marked underperformance to record high profitability.
Profits at Morgan Stanley rose 69% in the second quarter bolstered by brokerage margins in excess of 18% and trading results that significantly beat expectations. Overall the bank earned 43 cents in EPS on a net profit from continuing operations of about $1 billion.
While those numbers pale in comparison to the $3.70 in EPS and near $2 billion in profit Goldman Sachs earned in the second quarter, investors are cheering the bank's results.
Morgan Stanley shares were rising nearly 5% in Thursday trading, while Goldman's fell about 2% on its better-than-forecast Tuesday earnings. Year-to-date Morgan Stanley shares have gained nearly 50%, about double the gain of Goldman Sachs.