Investment Thesis

The Institutional Securities ("IS") segment of Morgan Stanley (contributing 45.5% of total net revenues in 2024) includes capital raising; financial advisory services that include advices on mergers and acquisitions (M&As), restructurings, real estate and project finance; corporate lending; sales, trading, financing and market-making activities in equity and fixed income securities and related products, including foreign exchange and commodities; benchmark indices and risk management analytics; and investment activities. The Wealth Management ("WM") segment (46%) provides brokerage and investment advisory services covering various investment alternatives; financial and wealth planning services; annuity and other insurance products; credit and other lending products; cash management services; retirement services; and trust and fiduciary services and engages in fixed income principal trading. The Investment Management ("IM") segment (8.5%) provides global asset management products and services in equity, fixed income, alternative investments that include hedge funds and funds of funds, and merchant banking including real estate, private equity and infrastructure, to institutional and retail clients through proprietary and third-party distribution channels. The segment also engages in investment..

• Warning! GuruFocus has detected 3 Warning Sign with MS.

Investment Upsides:

Morgan Stanley has lowered its reliance on capital markets for income generation. The company's focus on expanding its wealth and asset management operations and the strategic acquisitions, including Eaton Vance, E*Trade Financial and Shareworks, are steps in that direction. These moves have bolstered its diversification efforts, enhanced stability and created a more balanced revenue stream across market cycles. Both businesses' aggregate contribution to total net revenues jumped to more than 55% in 2024 from 26% in 2010. We project both the segments' total contribution (in aggregate) to the top line to be 55.2% in 2025. Further, the WM segment's total client assets witnessed a five-year (2019-2024) compound annual growth rate (CAGR) of 18.1%, while the IM segment's total assets under management recorded a CAGR of 24.7% over the same period. The trend is expected to keep improving as the operating environment becomes more favorable. For 2025, we project the WM segment's total client assets to grow 1.2% and the IM segment's total AUM balance to rise 4.3% on a year-over-year basis. As global deal-making came to a grinding halt at the beginning of 2022, it weighed on Morgan Stanley's IB performance. The company's IB fees (in the IS segment) plunged 49% in 2022 and 13% in 2023. Nonetheless, the trend has been reversing. In 2024, IB fees jumped 35% as clarity on several macroeconomic matters, the higher chances of the soft landing of the U.S. economy and interest rate cuts globally drove deal-making activities. The company will likely witness continuous improvement in IB fees, driven by a healthy and diversified merger & acquisition (M&A) pipeline. Management noted pipelines in the M&A product that are the highest in seven years. We expect IB revenues in the IS segment to witness a CAGR of 6.2% by 2027.

Morgan Stanley's partnership with MUFG is expected to keep supporting profitability. In 2023, the companies announced plans to deepen their 15-year alliance by merging certain operations within their Japanese brokerage joint ventures. The new strategic alliance will see combined Japanese equity research, sales and execution services for institutional clients at Mitsubishi UFJ Morgan Stanley Securities and Morgan Stanley MUFG Securities. Also, their equity underwriting business will be rearranged between the two brokerage units. These efforts will solidify the company's position in Japan's market. Morgan Stanley has a solid balance sheet. As of Dec. 31, 2024, the company had a long-term debt of $284.3 billion, with only approximately $21.9 billion expected to mature over the next 12 months. The company's average liquidity resources were $345.4 billion as of the same date. The company's investment-grade long-term credit ratings of A1, A- and A+ from Moody's, S&P Global Ratings and Fitch Ratings, respectively, and a stable outlook allow easy access to the debt market. The company is, thus, expected to be able to meet near-term debt obligations, even if the economic situation worsens.

Valuation

Morgan Stanley's shares are up 22.9% in the past six months and 37.3% over the trailing 12-month period. Stocks in the financial services sub-industry are up 19%, while those in the finance sector are up 7.2%, over the past six months. Over the past year, the sub-industry is up 27.7% and the sector is up 16.7%. The S&P 500 index is up 4.6% in the past six months and 13.7% in the past year. The stock is currently trading at 13.80X forward 12 months earnings, which compares to 12.58X for the sub-industry, 17.37X for the finance sector, and 22.34X for the S&P 500 index.

Investment Risks

Morgan Stanley's over-dependence on the performance of the capital markets to generate trading revenues is worrisome. While sales & trading revenues (in the IS segment) declined in 2023, heightened volatility and a rise in client activity resulted in improved trading performance in 2021, 2022 and 2024. The volatile nature of the business and expectations that it will gradually normalize toward the pre-pandemic level are likely to make growth challenging in the upcoming quarters. We expect equity and fixed-income revenues to rise 3.6% and 5.8% in 2025, respectively, but not reach the levels of 2021 anytime soon. Despite Morgan Stanley's restructuring and streamlining efforts that resulted in achieving its cost savings target of $1 billion in 2017, overall expenses have been increasing. Though expenses declined in 2022, it witnessed a five-year (ended 2024) CAGR of 7.8%. Expenses are expected to remain elevated on the steady increase in revenues (leading to higher compensation costs) and inflation, as well as the company's investments in franchise and inorganic growth efforts. Our estimates for total non-interest expenses suggest a CAGR of 2.8% by 2027. Morgan Stanley's trailing 12-month return on equity (ROE) undercuts its growth potential. The company's ROE of 14.29% compares unfavorably with ROE of 17.11% for the S&P 500. This reflects that it is less efficient in using shareholders' funds.

Guru Activity

Over the past few Gurus have shown their faith on Morgan Stnley and Ted Pick's stewardship. Morgan Stanley has rewarded them with increased stock price over the course of the past 3 quarters. The increased purchases of shares by Gurus indicate greater confidence in Morgan Stanley's increased focus on the wealth management arm and diversify its revenue channels.

Recommendation

Morgan Stanley's capital distribution plans are impressive. Following the 2024 stress test results, the company announced an increase in its quarterly dividend by 8.8% to 92.5 cents per share. It also reauthorized a new multi-year share repurchase program of up to $20 billion, effective the third quarter of 2024 and with no expiration date. As of Dec. 31, 2024, approximately $18.5 billion shares remained available under the authorization. The company is expected to be able to continue with efficient capital distribution activities, given its solid liquidity position and earnings strength. Through this, it will keep enhancing shareholder value. Over the past five years, the stock has traded as high as 17.26X and as low as 5.21X, with a 5-year median of 12.80X. With a target price of $138, reflecting 15.96X forward earnings, my recommendation is that Morgan Stanley would outperform the broader benchmark.