How Long Can Morgan Stanley Go up on a Loss?
Morgan Stanley (NYSE: MS) rose nearly 8% in pre-market trading Thursday despite posting a loss, since the bank beat analyst expectations after Goldman Sachs (NYSE: GS) posted better-than-expected results Wednesday.
Morgan Stanley posted a loss of $275 million, or 15 cents per share, largely due to a settlement with financial services and insurance firm MBIA Inc (NYSE: MBI) that cost the investment bank $1.7 billion. However, the bank also reported lower revenues of $5.7 billion, a fall of 26%. The loss compares to a profit of $600 million (41 cents per share) reported for Q4 2010, which had helped the bank's stock briefly sustain upward momentum before falling in 2011.
As with other investment banks, Morgan Stanley's loss is the result of less investment opportunities translating into lower revenues, which were down $5.7 billion. Morgan Stanley hasn't seen such weak revenue figures since Q2 2009.
The bleak numbers were better than expected, with analysts expecting a loss nearly three times greater at 57 cents a share, causing the stock price to reach a level unseen since the end of October. The company also declared a dividend of 5 cents per share.
Due to the loss and rising stock price, Morgan Stanley's fundamental value has fallen, but that isn't stopping investors from nabbing the stock in premarket trading thanks to hope that this is the beginning of a turnaround. There is good reason to expect one; with the IMF looking for funds to bolster Europe and investor confidence that the Federal Reserve will continue to keep rates low.
There is also slightly increased confidence in the American economic environment as some indicators suggest that the retail and manufacturing sectors are strengthening and the housing market is at least stabilizing in the long term. A stronger economy would help Morgan Stanley identify and capitalize on more investment opportunities.
However, the macroeconomic situation is not perfect, as eurozone bond markets are still intolerably unstable and a Greece default seems closer than ever. Although the markets seem to have largely ignored S&P's downgrade of eight European nations last week, the lingering concerns of eurozone stability may return. Since Morgan Stanley is largely invested in the bond and currency markets, this is a big concern for them. The bank has already begun exiting the European markets, with a reduction of net exposure to Italian debt from $4.9 billion to $1.5 billion. While this lowers its risk level, it also lowers the potential for big gains on Italian debt counter to that risk.
An interesting note in the bank's results is an uneven performance between its different business units. Its Global Wealth Management Group accounted for $13.4 billion of the company's $17.2 billion revenues for 2011, so the company is very exposed to volatility in global markets. However, the company was able to keep its GWM Group activities profitable, with a continuing operation income of $244 million.
However, the bank's Institutional Securities arm, which raises capital and offers gives financial advice on corporate restructuring, mergers and acquisitions, and project financing, plummeted from a $3.4 billion gain to a $779 million loss. This is due to a widespread decline in revenues, with equity sales and trading net revenues down to $1.3 billion.
Morgan Stanley can take solace in the fact that the loss is unlikely to be repeated in Q1 2012 if it can avoid further litigation and find a modest growth in revenues, particularly in trading and corporate financing operations.
This is likely to occur thanks to an improving economic condition, but the bank will also need to make itself leaner. In 2011, Morgan Stanley paid $16.4 billion in compensation--over half of the company's total net revenue. Compared to JPMorgan Chase (NYSE: JPM), which paid 34 percent of total revenue as compensation, Morgan Stanley looks bloated and inefficient.
Morgan Stanley was able to cut its compensation expenses from $4 billion last year to $3.8 billion in Q4 2011, thanks to job cuts such as its Scrooge-like slashing of 1,600 jobs just before Christmas last year. This compares to a cut of 2,400 jobs at Goldman Sachs (NYSE: GS) and JPMorgan cut an undisclosed number of positions--although probably a figure much higher than Goldman Sachs, whose compensation-to-revenue ratio was at 42 percent for 2011.
The job cuts should help the banks stay more competitive and increase net profits due to lower operational expenses in 2012, but they also run the risk of lowering the banks operational capabilities at a time when at least the U.S. economy might begin to improve. Such improvement may not hit Wall Street as directly as in the last decade with the banks' current operational model, since financing mortgages is unlikely to drive the American economy in the new decade.
Looking ahead, investors may see a sustained rise in Morgan Stanley as investors rejoice at the better-than-expected numbers, but the bank's formerly attractive P/E ratio is going to be hit by last quarter's loss. Some analysts maintain that a loss in share price may be forthcoming for the investment bank.
Traders who believe that Morgan Stanley will continue to rise might want to consider the following trades:
- Buy and hold Morgan Stanley. If you think the bank is going to post stronger numbers in the coming year as it profits from a stronger American economy, it might be a good long term hold as the stock price remains closer to its 52-week low than its high.
- Play Morgan Stanley for the short term. If you think investor confidence will remain with the investment bank only for this earnings season, you might want to ride the wave and exit before uncertainty in Europe drags on the stock.
Traders who believe that Morgan Stanley is on a temporary high for now may consider alternative positions:
- Short MS now that investors are briefly enjoying the better-than-expected loss. A loss is still a loss and the market is fickle, so people might begin to pull their money out of the bank as they realize that the drop in revenues might be the new normal for the company.
- Consider a long-term buy of other investment banks, such as the leaner JPMorgan and Goldman Sachs. Both banks have lower operational costs relative to revenues, which may help them post bigger gains in the coming months than Morgan Stanley, who, despite the recent layoffs, remains relatively bloated.
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