Financial stocks have underperformed over the past year, though one stock in our Wealth Builder's Portfolio has been a notable exception, observes Elliott Gue, editor of Capitalist Times.
Investment bank Morgan Stanley (MS) has delivered a total return of 30.9% since we added the stock to the Portfolio, compared to the 19.5% gain posted by the S&P 500 Financials Index. Morgan Stanley should benefit from three upside drivers in coming months:
- Rising profit margins in the firm's wealth management division;
- A cyclical recovery in key markets; and
- Growth in lending activity.
Wealth management accounts for about 44% of the investment bank's total revenue and almost 60% of its net income. With over $2 trillion in assets under management, the retail brokerage business is the crown jewel of Morgan Stanley's business.
Margins topped 20% in the second quarter, up from 18% in 2013 and 14% in 2012. Management also reiterated its confidence that the wealth management division will achieve margins of 22% to 25% by the end of 2015.
Wealth management is a more stable business than trading. Clients are either charged a fee based on the amount of assets held with Morgan Stanley or transactional fees based on their trading activity.
At the end of the second quarter, almost 40% of the assets under management in this division were held in accounts that pay Morgan Stanley a fee regardless of trading activity or the stock market's performance.
An uptick in lending activity should also fuel revenue and earnings growth. Morgan Stanley continues to leverage its network of more than 16,000 financial advisors to sell mortgages, securities-based loans, and other basic loan products to its client base.
The profitability of this lending push should improve as interest rates normalize over the next few years. And given its wealthy client base and Morgan Stanley's familiarity with their financial health, the risk associated with these loans is minimal.
At the end of 2013, loans accounted for roughly 30% of Morgan Stanley's $126 billion in total assets. Morgan Stanley aims to increase lending to 47% of its total assets, a strategic shift that should dramatically increase interest income without making concessions to credit quality.
During Morgan Stanley's second-quarter earnings call, CFO Ruth Porat noted that the bank's business in Europe is the strongest it has been since the beginning of 2012, before the worst of the region's financial crisis.
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