We recently made a list of Morgan Stanley’s Best Overweight & Quality Stocks: Top 25 Stocks. In this piece, we will look at where East West Bancorp, Inc. (NASDAQ:EWBC) ranks on the list of the top overweight and quality stocks.
The close of September has cemented the paradigm shift on Wall Street. With the Federal Reserve’s first interest rate cut being all that investors could hope for as it reduced rates by 50 basis points, since the cut, the flagship S&P stock index and the broader NASDAQ stock index are up by 2% and 3%, respectively. The rate cut has also now moved Wall Street’s focus to the next big catalyst for the stock market, i.e, the third quarter earnings season.
For a market that has touched new highs this year due to artificial intelligence, the second quarter earnings season was nothing short of fireworks. It saw the AI narrative wobble temporarily after mixed results from the world’s leading AI GPU designer and the semiconductor industry reckoned with the fate of the semiconductor manufacturing stock that ranked 5th on the list of Jim Cramer’s Top 12 Must-Watch Stocks.
Starting with the chip maker, its second quarter earnings were nothing short of a bloodbath. They saw the firm’s non GAAP net income drop by a whopping 85% annually and turn a year ago GAAP net income into a non GAAP loss of $1.6 billion. At the same time, its gross margins dropped by 0.4 percentage points, and in the worst example of the cherry on top, the firm also announced that it will be suspending dividends starting from the fourth quarter. As a result, its shares tanked by 30% after the earnings, and since then, we’ve seen multiple reports claim that other companies are interested in acquiring it.
As for the GPU designer, its second quarter revenue jumped by 122% – a no small feat considering that the year ago quarter’s revenue was $13.5 billion. However, even as the Q2 revenue of $30 billion beat analyst estimates of $28.7 billion which was fueled by its AI data center division’s revenue jumping by 154% annually, the shares fell by 6% in extended trading. At the heart of the fall was a tepid third quarter guidance of $32.5 billion (analyst estimates were $31.77 billion), a gross margin miss by 0.1 percentage point, a Q3 margin guidance miss by 0.5 percentage points, and the delay of its Blackwell GPU to the fourth quarter. For investors already worried about the ability of AI to generate a profit, the margin miss in particular wasn’t comforting. Consequently, since the earnings report, the firm’s shares are down by 1%.
However, investment bank Morgan Stanley sent the GPU designer’s shares soaring by 6.8% in September in a bullish note that shared that the firm could earn $10 billion in its fourth quarter alone from the latest Blackwell chips. This upgrade came on the back of MS remaining consistent in its analysis of the stock market this year. The key themes that it has identified are the labor market, commercial real estate, and the split in the stock market between large and small cap stocks.
In July, the bank shared that there was “ample room for equities performance to broaden, but this requires a cyclical recovery.” In simpler terms, it means that MS believed that for small cap equities to catch up to large caps in performance, the economy has to perform well. If you’re wondering how wide this gap is, data shows that for small and medium cap and large cap stocks which are in the top 20% in terms of free cash flow margins, the small and mid caps have a forward price to earnings ratio of 0.74x relative to large caps as of April 2024, which is quite low when compared to the April 2009 peak of 1.62x. MS reiterated this belief in its August report, which shared that small cap outperformance “requires economic growth acceleration with lower interest rates. While recent inflation data and the resulting decline in rates was a lift to small cap, softer economic data may constrain its continued outperformance.”
However, MS’ September report took somewhat of a different tune. It focused on the clean energy and infrastructure investments in the US to share that these could help some segments of the American stock market that are typically dependent on growth in economic activity. Government spending through the Inflation Reduction Act (IRA), the Bipartisan Infrastructure Law (BIL), and the CHIPS and Science Act have led to roughly $500 billion in commitments by the private sector to invest in a diverse set of areas ranging from roads, to clean energy manufacturing and heavy industry.
As per the bank, “Government policies such as the CHIPS Act, the Inflation Reduction Act (IRA), and the Infrastructure Act are sponsoring growth in many areas of U.S. manufacturing. These trends could offer through-the-cycle structural support to areas of the economy that are traditionally very cyclical.” On the data front, MS reveals that while in 2022, US manufacturing capacity as a percentage of 2017 output sat at ~126%, this has jumped to nearly 129% as of 2024.
Shifting gears, the third quarter earnings season will soon start to shape how investors view the market. Data from LSEG shows that the flagship S&P index is expected to deliver 5.4% annual earnings growth during Q3. FactSet is more cautious, as it shares that the index should grow earnings by 4.6% annually to mark its sixth straight quarter of growth. MS is of the view that the economy has to continue to deliver on the data front if the stock market is to perform well.
In a recent podcast, the bank’s chief investment officer and chief strategist, Mike Wilson, shared that “the unemployment rate will need to decline and the payrolls above 140,000 with no negative revisions to prior months. Meanwhile, I am also watching several other variables closely to determine the trajectory of growth. Earnings revision breadth, the best proxy for company guidance, continues to trend sideways for the overall S&P 500 and negatively for the Russell 2000 small cap index. Due to seasonal patterns, this variable is likely to face negative headwinds over the next month.”
Our Methodology
To make our list of Morgan Stanley’s best Overweight and quality stocks, we ranked the bank’s recent list of 66 stocks with Overweight ratings, a higher than median quality score, and one month upward EPS revisions by their percentage one month average analyst revisions. The average EPS data was sourced from Yahoo Finance as of September 26th 2024, and the top 25 stocks with non zero percent revisions were selected.
For these stocks, we also mentioned the number of hedge fund investors. Why are we interested in the stocks that hedge funds pile into? The reason is simple: our research has shown that we can outperform the market by imitating the top stock picks of the best hedge funds. Our quarterly newsletter’s strategy selects 14 small-cap and large-cap stocks every quarter and has returned 275% since May 2014, beating its benchmark by 150 percentage points. (see more details here).
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East West Bancorp, Inc. (NASDAQ:EWBC)
Number of Hedge Fund Holders In Q2 2024: 27
Average Analyst EPS % Revision: 0.5%
East West Bancorp, Inc. (NASDAQ:EWBC) is a regional bank that is primarily a mega lender. This is because as of H1 2024, 84% of the bank’s interest and dividend income came through loans receivable. As a result, East West Bancorp, Inc. (NASDAQ:EWBC) shares are particularly sensitive to interest rates. For instance, during the bank’s fiscal Q2, its 49% profit margin dropped by 6 percentage points over the year ago quarter’s 55%. This also drove net income down 7.6% to $288 million. Consequently, post earnings, the stock dipped by 12.6% over the next couple of days. Looking at East West Bancorp, Inc. (NASDAQ:EWBC) loan portfolio, $37 billion out of $52 billion of loans are made to the commercial sector. While these loans are typically more robust when facing inflationary pressure, out of the $37 billion, $20 billion are in commercial real estate. As a result, East West Bancorp, Inc. (NASDAQ:EWBC) is vulnerable to economic downturns that could increase defaults. Additionally, high interest costs have also constrained the bank’s ability to make new loans, and when management disclosed this in September, East West Bancorp, Inc. (NASDAQ:EWBC)’s shares dropped by 6% over the next week.
During the Q2 2024 earnings call, East West Bancorp, Inc. (NASDAQ:EWBC)’s management provided important details about its commercial real estate portfolio:
“With regards to commercial real estate loan maturities, as of June 30, 2024, 5% of outstanding balances are scheduled to mature by the end of 2024 and 10% of outstanding balances will mature in 2025. For office loans specifically, 8% of outstanding balances will mature in 2024 and 16% will mature in 2025. We remain vigilant and proactive in managing our credit risk. Based on what we know today we continue to expect quarterly net charge-offs to be in the range of 15 basis points to 25 basis points for the foreseeable future.
Turning to Slide 9, the total allowance for loan losses increased $14 million quarter-over-quarter, driven by the expected economic outlook and also loan growth during the quarter, resulting in allowance for loan losses coverage ratio of 1.30%. Within commercial real estate, we increased the reserve for office loans by $7 million, bringing the total coverage ratio to 3.10% of office loans. We believe our loan portfolio is appropriately reserved as of June 30, 2024.”
Overall EWBC ranks 12th when we look at Morgan Stanley’s top overweight stocks. While we acknowledge the potential of EWBC as an investment, our conviction lies in the belief that some AI stocks hold greater promise for delivering higher returns and doing so within a shorter timeframe. If you are looking for an AI stock that is more promising than EWBC but that trades at less than 5 times its earnings, check out our report about the cheapest AI stock.
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Disclosure: None. This article was originally published on Insider Monkey. All investment decisions should be made after consulting a qualified professional.