We maintain a database of quarterly 13F filings from hedge funds and other notable investors for a variety of purposes. One of our activities is the development of workable investing strategies, and we’ve actually discovered that the most popular small cap stocks among hedge funds generate an average excess return of 18 percentage points per year (learn more about our small cap strategy). We also like to evaluate large changes in hedge fund positions, and when going through the most recent filings we noticed that billionaire Louis Bacon’s Moore Global initiated a position of 4.5 million shares in Morgan Stanley during Q1, making the bank one of its top ten picks overall (see Bacon's stock picks). Morgan Stanley was also Caxton Associates’s second largest holding, by market value, following a large increase in the fund’s position. Caxton was founded by billionaire, Bruce Kovner.
A closer look at Morgan Stanley
Morgan Stanley’s stock price is up 89% in the last year, including 34% year-to-date, and over 20% quarter-to-date. Decent earnings numbers from Q1 and the fourth quarter of 2012 (with numbers for that period coming in well above expectations) fueled these gains. Still, there is some value case remaining for Morgan Stanley. For one, it trades at a discount to the book value of its equity with a P/B ratio of 0.8.
The bank’s 10-Q for the first quarter of 2013 showed decent growth rates in revenue, notably from trading activities and from net interest tilting positive. Overall, revenue was up 18% versus a year earlier. Non-interest expenses were actually down in absolute terms, with a 5% drop in compensation and benefits, in particular. As a result, Morgan Stanley earned $0.48 per share. The trailing P/E is high because of poor results in previous periods, but if we annualize these most recent results, we get an earnings multiple of 13, meaning the company needs little improvement going forward in order to be considered a value play. Wall Street analysts expect $2.55 in EPS for 2014, placing the current price at only 10 times forward earnings estimates.
Morgan Stanley’s peer group
Of course, a low P/B ratio and low forward P/E aren’t out of the ordinary for banks in the current environment. Citigroup and Bank of America are similar to Morgan Stanley in that they are recovering from periods of low earnings in their businesses, with analyst expectations implying forward P/Es of 9 and 10, respectively, at those stocks. Revenue was up 10%-15% at each of these banks last quarter, compared to the first quarter of 2012, with large percentage increases in earnings. In addition, these two peers also trade below book value. In Citi’s case, the discount is about the same size as it is at Morgan Stanley, while markets are even more skeptical of Bank of America’s assets (specifically, its P/B ratio of 0.7).
We can also compare Morgan Stanley to JPMorgan Chase . Recent business conditions have been better here (net income has been up over 30% over the last year), going by the most recent reports. The stock trades at 9 times earnings, whether we consider trailing numbers or projections for 2014. With any potential concerns about the departure of CEO, Jamie Dimon, likely avoided for now, JPMorgan Chase seems like an alternative that is slightly less dependent on future improvements than the other banks we’ve discussed. It also trades in line with book value, and therefore wouldn’t be considered overvalued from that perspective either.
The closest peer for Morgan Stanley, in terms of business structure, is probably pure-play investment bank, Goldman Sachs . Goldman’s trailing P/E is 11, which places it at a discount to Morgan Stanley, even if we annualize that bank’s Q1 numbers. This makes us a bit more comfortable thinking of Goldman as a potential value investment, and like JPMorgan Chase, an investor wouldn’t be counting on the bank generating better results when buying at current prices. We would note that in Goldman Sachs’s most recent quarter, there was little change in revenue compared to the same period in the previous year, and while earnings were up, we’d be concerned that further increases in net income, more or less through margins alone, would not be sustainable.
At this point, JPMorgan Chase seems like the most attractive large bank to us, given that it is already generating enough earnings to make its stock price look attractive, as well as seeing improvements in its business. As far as the two large pure-play investment banks are concerned, however, it’s a tougher call, as Morgan Stanley has certainly turned in a promising quarter. It might be worth watching to see if the company continues to experience higher growth than Goldman.