The third quarter of 2019 shaped up to be a tough one in the investment banking and wealth management space. Challenge accepted, Morgan Stanley (MS) - Get Morgan Stanley Report delivered a strong revenue and earnings beat on Thursday, justifying a bump of nearly 4% in share price that reflected the company's solid execution across its service portfolio.
Little Macroeconomic Support, Solid Results
The list of macro-level headwinds was extensive, and included tighter interest rate spreads as the yield curve flattened, decreased business sentiment, the unresolved trade war between the U.S. and China and the lingering Brexit drama, only to name a few factors. Aside from resilient consumer activity, particularly in the U.S., most other economic indicators suggested that the third quarter would likely not be a walk in the park for banks, especially those whose revenues are more heavily dependent on institutional client activity.
Given this scenario, investors will probably feel good about Morgan Stanley's reported low-single digit revenue and earnings per share growth. Better yet, there wasn't much weakness to be found across the company's key segments, not even in the more volatile and often unpredictable institutional securities division.
In fact, the sizable $400 million revenue upside to consensus expectation likely came primarily from this part of Morgan Stanley's business. Despite repeated warnings over the past several months by peers JPMorgan (JPM) - Get JPMorgan Chase & Co. Report and Bank of America (BAC) - Get Bank of America Corp Report about a slowdown in M&A and capital market activity, Morgan Stanley managed to increase investment banking revenues by a respectable 5% in the third quarter. More relevant due to its size, sales and trading grew at an even higher rate of 10%, driven in part by strong client activity in fixed income.
Wealth management revenues may have looked weak on the surface, having dipped 1% year-over-year following modest growth in recent quarters. But the lack of traction here was driven primarily by losses on investments associated with deferred compensations plans, which can be lumpy from quarter to quarter. More importantly, the asset management sub-segment, a steadier revenue generator accounting for about one-fourth of Morgan Stanley's top line, experienced 3% growth on the back of higher asset levels and continued positive flows.
The caveat to Morgan Stanley's otherwise strong results were operating expenses that increased at a substantially faster pace than revenues, causing moderate loss of operating leverage. Most of the cost pressures, however, may have been confined to the third quarter and not necessarily indicative of an unfavorable trend going forward. For instance, compensation expenses were particularly high due to increased deal-based institutional securities revenues, while litigation seems to have pushed non-compensation costs higher.
Execution Meets a Cheap Stock
In the third quarter, Morgan Stanley provided evidence that it can deliver strong results, even when the macroeconomic landscape looks far from ideal. To be clear, risks will continue to exist, both at macroeconomic (business and consumer activity, global GDP growth, market volatility) and sector levels (disruptions in wealth management, tight competition in banking and M&A). But the New York City-based bank seems to be doing a competent job at attracting funds flow, executing on its banking and advisory pipeline and growing assets under management.
Investing in Morgan Stanley is more easily justified by the stock's price tag. Forward P/E of 8.7 times is about as low a valuation multiple as one can find in the large financial institution space, while a price-to-book ratio of 1.0 also suggests attractive pricing. It does not hurt that shares yield a respectable 3.3% in dividends, which also makes Morgan Stanley a compelling proposition for income-seeking investors.
The author has no positions in any stocks mentioned in this article.