Morgan Stanley (MS 0.31%) reported another solid quarter of growth earlier this month, driven by stellar performance across its segments. The company has done well in diversifying its revenue streams so that it could perform in all kinds of markets, and it continues to benefit from its E*Trade and Eaton Vance acquisitions that were closed in October 2020 and March 2021, respectively.
Morgan Stanley crushed it from an investment banking perspective, and the firm expects to see strength from this segment going into the fourth quarter and 2022. According to Alan Felder, Managing Director for UBS's OneBank Partnership, investors should expect to see robust M&A activity continue in 2022 as interest rates remain low and public and private firms sit on a large amount of cash available for future investment opportunities.
Let's look at what else this month's earnings report tells us about Morgan Stanley going forward.
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Strong earnings across the board
In the third quarter, Morgan Stanley posted revenue of $14.8 billion, up 26.5% from the same quarter last year, while net income of $3.7 billion was up 37%.
Morgan Stanley beat analysts' estimates, posting revenue 5.9% above estimates and earnings per share (EPS) of 20.7% above estimates. Asset growth drove fee-based revenue growth, and a strong backdrop for investment banking activities led to record revenue, led by mergers and acquisitions (M&A) and initial public offering (IPO) underwriting revenues.
Solid growth was seen across all of Morgan Stanley's segments. Institutional securities revenue of $7.5 billion was up 22.3% from last year -- driven by investment banking revenue, which was up 67% from the same quarter last year. The solid performance reflects strong demand for its equity underwriting services and M&A advisory services, which is at a record level in 2021.
What is management watching for in 2022?
One point that CEO James Gorman discussed during Morgan Stanley's earnings call was how volatility could increase in markets next year. Specifically, he pointed to the Federal Reserve's tapering activity and how the Fed's dot plot suggests interest rate increases will come next year too. Overall, he says "it's good to be watchful right now" and that there is "nothing to suggest there are any issues" but "over the next 18 months, we'll see more of that as the Fed starts to move."
One reason Gorman is keeping a watchful eye on interest rates is because this could ultimately affect M&A activity and cause investment banking revenue growth to slow down. While a gradual increase to interest rates may not have too big of an impact on deal-making, faster interest rate hikes could cause higher volatility in markets from interest rate shocks which could discourage deal-making activity.
Making moves to give future earnings more stability
While M&A activity is expected to remain robust, faster-than-expected interest rate hikes could impact Morgan Stanley's investment banking division. This is a big reason why the firm spent $20 billion to acquire asset manager Eaton Vance and electronic trading platform E*Trade in the past couple of years. According to Gorman, each deal "provides more balance to our business model. It's more wealth management revenue, it's more stability, it's less volatile than the core markets business."
The acquisitions are already driving growth for Morgan Stanley across segments, with wealth management revenue in Q3 growing 27.5% to $5.9 billion year over year while investment management revenue grew 37.6% to $1.5 billion. Through these two acquisitions, client assets have grown $400 billion this year, bringing total combined client assets under management to $6.2 trillion.
If Morgan Stanley were to see a shock to investment banking revenue in 2022 or beyond, the firm is well-positioned to capture revenue from its other sources. Increased volatility could increase trading activity on its E*Trade platform, and higher rates could drive increased interest income for the firm. This stability to Morgan Stanley's future earnings is one reason why I continue to be bullish on this value stock, which trades with a price-to-earnings (P/E) ratio of 13.2 while competitor Charles Schwab trades at a 31.6 P/E ratio.
