Nikada
Capital asset-light companies are a great asset class for investors who prize high profitability, shareholder returns, and a hedge against inflation. It’s important, however, to stick with moat-worthy names with a strong brand reputation. This brings me to Morgan Stanley (NYSE:NYSE:MS) which has emerged as a much stronger enterprise in recent years. This article highlights why MS looks enticing, especially after recent price and market volatility, so let’s get started.
Why MS?
Morgan Stanley is a leading global financial services firm that’s a strong player in investment banking, securities, and wealth management services. Its roots can be traced back to 1924 and today, has around a staggering $5 trillion in client assets. Morgan Stanley’s deep-rooted client relationships and efficient scale has enabled it to achieve industry leading returns. This is reflected by its A+ profitability grade with a strong 13.6% return on equity.
Moreover, MS has shifted towards a more stable business model in recent years, by moving towards wealth management and away from its more volatile investment banking line of business. That’s because investment banking by nature is more capital-intensive compared to the steady and fee-based nature of the wealth and asset management business, in which returns on equity can range from the high teens to the 20s percent. These segments were further boosted by Morgan Stanley’s acquisitions of discount brokerage E-Trade and asset manager Eaton Vance last year.
This is not to say, however, that MS doesn’t come with headwinds. As with any financial services companies, market volatility in the pricing of securities can result in a drag in AUM-related earnings. This was reflected by significant movement in the investments related to deferred cash based compensation plans (most likely restricted stock units), which resulted in a significant drag on top-line revenues across the firm, particularly in wealth management during the second quarter.
Moreover, legal costs amounting to $200 million related to employees’ use of personal devices and the firm’s recordkeeping requirements also contributed to the EPS decline to $1.39 from $1.85 in the prior year period.
Looking forward, the market rebound since the beginning of July, despite recent volatility, could yield better earnings results for Morgan Stanley. Growth can also come in the form of net new assets under management, with management expecting $1 trillion in net new assets every 3 years. Moreover, the acquisition of E-Trade has added incremental new customers which the firm can convert from self-advised to full-service, as reflected by management during this week’s Barclays (BCS) Global Financial Services Conference:
Now we have relationships with 16.5 million clients and that number is growing very quickly. And when people ask me, what are some of the metrics that I look at on a regular basis to manage the business? The number of relationships that we have and the growth of those numbers of relationships that we have that go into that funnel that is something that I look at on a regular basis because each of those relationships represents real opportunity.
And obviously right now a lot of those relationships are digital because they came in the workplace they came in the self-directed channel. So the way we think about it is that it’s our job through technology, through deepening relationships with clients by every interaction with our client we learn more about the client. We can think about them as an individual.
We want to understand we want to know each client we have as an individual through every touch point we have with them regardless of what channel regardless of how we interact with them and we want to build those trust-based relationships and deepen those relationships with those clients.
Meanwhile, MS maintains a strong BBB+ rated balance sheet and pays a healthy 3.6% dividend yield that’s well-covered by a 37% payout ratio. MS also has 8 years of consecutive dividend growth under its belt, and has a 5-year dividend CAGR of 27.6%. Notably, much of this impressive dividend growth can be attributed to the doubling of the quarterly dividend rate in the middle of last year.
Lastly, I see the market rout so far this week as presenting a good buying opportunity, at the current price of $87 with a forward PE of 13.1. This is considering the quality and scale of the enterprise and the 12% to 16% annual EPS growth that analysts estimate over the next 2 years. Sell side analysts have a consensus Buy rating on MS with an average price target of $95.17, translating to a potential one-year 13% total return including dividends.
Investor Takeaway
In conclusion, I believe that MS is a well-respected enterprise that’s trading at a reasonable valuation following the market sell-off. The firm has strong growth prospects coming with organic opportunities and stemming from recent acquisitions. Meanwhile, the dividend now yields 3.6% and is well-covered by earnings. As such, I view MS as being a buy on the drop for potentially rewarding long-term returns.
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