Monday, July 23, 2018

Morgan Stanley Presents a Rare Conjunction

Overview:

Morgan Stanley provides investment banking products and services to its clients including corporations, governments, financial institutions and individuals.  It operates though the following business segments: Institutional Securities, Wealth Management and Investment Management.  The Institutional Services segments provides financial advisory, capital-raising services and related financing services on behalf of institutional investors.  The Wealth Management segment offers brokerage and investment advisory services covering various types of investments, including equities, options, futures, foreign currencies, precious metals, managed futures, separately managed accounts and mutual fund asset allocation programs.  The Investment Management segment provides equity, fixed income, alternative investments, real estate and merchant banking strategies.  The company was founded by Harold Stanley and Henry S. Morgan.
Founded: 1935
Number of Employees: 57,633
Headquarters: New York, NY
CEO: James Patrick Gorman, MBA

Analysis Methodology:

This analysis will look at what we believe are relevant features of MS in order to determine if there is an investment opportunity.  It'll review price, yield curve, return, earnings, valuation, return measures and dividends.  We'll also review recent news articles and blog posts for relevant information.
This analysis will be peer based.  Peer-based analysis has several important advantages: it provides context for the analysis numbers, the opportunity for bench-marking and it can uncover other opportunities.

Peer Group

MS is in the finance sector and the investment banks/brokers industry.  Peers are in the same sector/industry, have a market cap within 50% of MS and trade on a U.S. exchange.  OTC stocks were not included.
This is the group:
Stock Name (Symbot)Last PriceMarket Cap
Credit Suisse Group AG (CS)$14.88$37.7892B
Goldman Sachs Group, Inc. (GS)$220.57$83.3106B
Morgan Stanley (MS)$47.40$84.0845B


Price:

This daily, 5 year price graph plots MS along with a relevant index, the S&P Financial Select Sector.  It's clear the the two run in tight tandem.
When we look at the price performance of the group we can see CS has lagged behind the other two and that all three stocks and the index have turned down.

Yield Curve

The following chart plots the difference between the nominal 30 year rate and the 3 month treasury bill.  Certainly the curve is getting flatter and February 2018 marked a new phase of flattening around the time the prices on both the individual stocks and the index started to decline.  A flattening curve can impact a banks earnings and we know that short term rates are coming up.  The question is how will the long term rates react?  If they do anything other than increase at least as much as the short term ones, we'll eventually get an inverted curve, indicative of a recession.  

Return:


The return is calculated as the price change over the past four years plus the dividend yield in each of the past four years.  We can see MS has given its shareholders the best return of the group.

Earnings:

This section of the analysis will review quality of earnings and earnings growth.

Quality of Earnings

A bank's financial statements are different from most other organizations.  Therefore we're using a modified quality of earnings calculation to determine how trustworthy the financials are.  The metric subtracts net operating cash flow from the net income available to common shareholders and divides the remainder by the average total assets for the period ((net income - net operating cash flow)/(beginning assets + ending assets)/2).  The larger the difference between net income and cash from operations, the less trustworthy the results.  In other words, the lower the score, the better.

Of the group MS is the best.

Year or Year Change in Earnings Per Share (Fully Diluted)

This metric looks at how many instances of year over year growth the company has been able to achieve.  We looked at the results of five years so the maximum year over year score is four.
MS has grown its EPS every year, an achievement its peers are not able to match.  This is an especially strong signal couple with the good quality of earnings results.
It is also worth noting that MS's earnings have been positive each year as were GS's.  CS's have been positive only in the two most distant years.

Valuation:

We'll review the PE ratio, the Ohlson's Clean Surplus (OCS) theoretical price (for more information about this interesting technique please see this article) and the Discounted Cash Flow (DCF) model. The price to earnings per share ratio tells us how much we are paying for a dollar of earnings, so a lower value is generally better.  The OCS & DCF models compute a theoretical stock price and the stock is undervalued if it's trading at a discount relative to the theoretical value. 
Please see the analysis notes for assumptions made for the OCS and the DCF model.
Here are the results for the three stocks:

PE RatioOCS theoretical priceDCF
CS35$9 (premium 40%)$9 (premium 40%)
GS24$149 (premium 32%)$207 (fair value)
MS15$35 (premium 27%)$93 (discount 27%)


CS is overvalued, GS is probably overvalued and MS is likely fairly valued.  

PBV, ROE and ROA:
There are three other important metrics to consider when evaluating a bank stock: price to book value, ROE and ROA.  We want to see high numbers for all of these metrics.  It's probably clear why we want a high return on equity and assets but the logic behind the price to book value ratio might not be as clear.

A high PBV indicates a small book value which in turn indicates the ability of the bank to turn it's liabilities - deposits, into assets - loans.  A PBV less than one indicates that the assets/loans are overvalued or the bank is earning a poor or negative return on the assets/loans.  A PBV greater than one indicates the assets/loans are undervalued or the bank is earning a positive return on its assets/loans.
The results of these calculations:


PBVROAROE
CS.88-.1%-2%
GS1.17.4%4%
MS1.23.6%7%

Dividends:

Both GS and MS have PBV greater than one but taking all of the factors into consideration indicates that MS is the best in class.
Dividends are one of the most important considerations when making a decision to invest in bank.  We'll look at dividend yield - the annual dividends divided by price and the growth in dividends.

Dividend YieldDividend Growth - 2 yearsDividend Growth - 5 years (average of Year over Year)
CS1.75%-32%-18%
GS1.31%7%9%
MS1.9%28%47%

MS has the highest yield and the highest growth rate.

Conclusion:
Morgan Stanley looks great on it's own but its appeal becomes even more clear when compared to its peers.  Their results are very good on a stand alone basis but when the peer analysis is brought in, it is the best choice in every single metric.  This is rare. 
This is the one to pick if you are looking to add a financial to your portfolio.  A caveat is to stay cognizant of what happens with the yield curve, it may end up having a continuing depressive effect on earnings and share price. 

Analysis Notes:

This article was composed on July 1, 2018 and has not been updated for this blog.
The only assumption used for the OCS model was the projected stock market return of 7%.  The output was reviewed and no other changes appeared to be necessary.
There was one common assumption for the DCF model - the projected market return of 7%.  The balance of the assumptions were tweaked for each individual stock. 
CS - a five-year average for dividends per share was used.  It's been declining year over year but prior to the most recent year it had been in the 70-80c range.  In the most recent year it dropped to 26c.  Also the growth rate was negative so the DSP was divided by the firm's rate.
GS - dividends have been growing so the most recent dividend was used.  For the growth rate, we used the average dividend growth rate over two years.
MS - dividends have been growing so the most recent dividend was used.  For the growth rate, we looked at both the dividend growth rate and the growth in operating income.  Both were so high they resulted in relative results.  The growth rate was then reduced so that there was a small remainder when it was subtracted from the firms rate.

Disclaimer:

We hope you found this analysis useful.
We put the same care into it as we would if we were considering an investment of our own money.  However INVRS, its parent company and its principals cannot be held responsible for any loss you might incur should you take a position based on this analysis.
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