Morgan Stanley earnings: Why profits were up 47%

Key points

• Morgan Stanley beat earnings estimates as profits rose 47%.

• The financial services firm got a big boost from investment banking.

• The stock has beaten the S&P 500 over the past 10 years.

Financial services behemoth Morgan Stanley (NYSE: MS) reported strong second quarter earnings with profits rising 47%, pushing Morgan Stanley stock higher.

The firm generated $15 billion in revenue, an 11% year-over-year increase, besting estimates by 5%. Net income surged 41% year-over-year to $3.1 billion, while earnings per share rose 47% to $1.82 per share. That crushed earnings estimates of $1.64 per share.

The stock price was rising on Tuesday, up modestly, about 1.3% as of mid-afternoon trading. Morgan Stanley stock has climbed 13% year-to-date.

There were a few major reasons that Morgan Stanley earnings were outpacing other banks and financial services firms. Let’s examine why profits were up 47%.

Investment banking revenue up 51%

Compared to JPMorgan Chase (NYSE:JPM), Bank of America (NYSE:BAC) and Citigroup (NYSE:C), among others, Morgan Stanley is mostly an investment bank and wealth manager. It does not have a big consumer banking arm, unlike the other three, so it does not rely as much on interest income. In addition, it is not as exposed to as much credit risk as the others, because it is not a major lender. That means it only has to set aside a fraction of what the large banks do for provisions for credit losses.

Instead, its performance is much more tied to investment banking and wealth management, more similar to Goldman Sachs (NYSE: GS). Thus, it is less diversified than some of the rival financial services giants, without as much interest income. However, in this current environment, when interest income and provision for credit losses have been a drag on earnings, Morgan Stanley has benefitted.

In has also seen an earnings boost from a resurgence in mergers and acquisitions and investment banking. For the previous two years, investment banking struggled under high interest rates, as deals dried up. But that is changing as Morgan Stanleyʻs investment banking revenue rose 51% in the second quarter, year-over-year, to $1.6 billion.

Further, the Institutional Securities business, which includes investment banking and equity and fixed income trading, rose 25% to $7 billion in the quarter.

Morgan Stanley also got a lift from its wealth and investment management businesses. Morgan Stanley is a leader in wealth management, which is its private banking, financial advisory, and brokerage arm. This business, which typically performs well when the markets are up, saw revenue climb about 2% in the quarter to $6.8 billion. Meanwhile, investment management revenue, which comes from fees from its funds and ETFs, rose 8% to $1.4 billion in Q2.

Lower rates will help

The big jump in investment banking revenue is in part indicative of M&A and underwriting activity returning, but it is also a reflection of how far down it was in 2023, one of the worst years in recent history for investment banking.

The primary culprit has been high interest rates, which makes the environment less than ideal as it makes the cost of borrowing more expensive and heightens the risk of defaults.

However, with interest rates expected to start dropping once the Fed lowers the federal funds rate, investment banking deals should start to pick up. As one of the top three investment banks, Morgan Stanley should see its revenue numbers increase.

It is also one of the leaders in wealth management, so the strength in two markets has allowed the company to navigate downturns well over the years.

Beating the S&P 500

Over the last 10 years, Morgan Stanley stock has posted an average annualized return of 12.8%, beating the S&P 500.

The stock is relatively cheap, with a P/E ratio of 15, and is well capitalized, with a common equity tier 1 ratio of 15.2%. It also raised its dividend to 93 cents per share this quarter, up from 85 cents.

Morgan Stanley stock has been a solid performer over the years, even through the lean times. And in an environment going forward that should provide some tailwinds, it looks like a decent option.