Earnings highlights
The company reported 22% year-over-year gains in consolidated revenue. The growth in revenue was primarily driven by growth in its institutional securities (investment banking) and investment management businesses. The institutional securities division generated 30% year-over-year growth in the second quarter. The investment-management segment reported a 48% year-over-year revenue increase. Performance in both segments contributed to the company’s earnings growth this past quarter.
Morgan Stanley (NYSE:MS) reported a 12% year-over-year increase to its operating expenses. The company’s costs increased at a slower rate than the growth in revenue, which resulted in 66% year-over-year groAwth in net income.
Morgan Stanley (NYSE:MS) reported diluted earnings per share of $0.45 in the second quarter, beating the analyst consensus estimate of $0.43. It beat earnings by $0.02, which isn’t bad when considering the high expectations analysts have had for the bank. The company grew diluted earnings per share by 41% (year-over-year) in the second quarter.
Outlook and investment thesis
The outlook remains fairly strong for the bank. Asset-management fees and investment banking activity are expected to grow in the foreseeable future. Analysts on a consensus basis anticipate the company to report earnings growth of 1,469% for the current fiscal year, and to follow that growth with 25.5% in 2014. The high rates of growth are due to the favorable macroeconomic environment paired with better cost management.
The performance of the bank is driven by whether or not stocks can continue to appreciate in value. If stocks are able to trend higher, this will have a favorable impact on both investment banks and asset-management firms.
Asset management flows
Source: Ycharts
Mutual fund flows have improved year-to-date. Mutual fund flows tend to peak towards the beginning of the year and taper off towards the end of the year (seasonal pattern).
Therefore, it is likely that the asset-management industry will experience year-over-year gains in performance fees for the third and fourth quarters, but will not experience a quarter-over-quarter gain in base fees. Base fee growth is different from incentive fees. The incentive fees should experience a boost because the broader stock market has been able to advance to new all-time highs. However the growth in base-fee income should taper on a quarter-over-quarter basis due to seasonal patterns.
Peer comparison of investment banking
Goldman Sachs Group Inc (NYSE:GS) and JPMorgan Chase & Co. (NYSE:JPM) were able to get a significant boost to their revenue this quarter. This was driven by the stock market. Total assets under management increased as equity inflows trended higher.
JPMorgan Chase & Co. (NYSE:JPM) fetched the most growth in investment-banking activities with 37% year-over-year revenue growth. Following that, Morgan Stanley (NYSE:MS) reported 30% year-over-year revenue growth from investment banking, and Goldman Sachs Group Inc (NYSE:GS) came in third with 29% year-over-year revenue growth from investment banking. All three firms reported fairly comparable performance from investment banking.
Demand for debt underwriting improved because interest rates were trending higher, so companies acted quickly to borrow money while interest rates were still cheap. Initial public offerings should be on the rise as companies will want to seek public offerings while stocks are trading at higher premiums.
Not to mention as a part of the JOBS Act (Jumpstart Our Business Startups Act), IPO requirements have lessened for smaller companies. This make the IPO process less expensive for small companies that want to publicly offer stock. This is another contributing factor that has helped to boost equity underwriting fees across the investment banks.
Difference between banks
Goldman Sachs Group Inc (NYSE:GS) and Morgan Stanley (NYSE:MS) are fairly similar in how their businesses are structured with the exceptions that Goldman Sachs is more active in currencies and commodities, asset management, and trading. Morgan Stanley (NYSE:MS) generates almost half of its revenue from private wealth management and is less exposed to asset management.
Private wealth management is service-driven whereas asset management is product driven. The approach is different because private wealth management tends to focus on financial planning, whereas asset management is about investing pools of gathered capital.
JPMorgan Chase & Co. (NYSE:JPM) is perhaps the most diversified bank, making it a universal bank. This means it’s involved in asset management, private wealth management, investment banking, commercial banking, and consumer banking. The diversification of products and services gives JPMorgan Chase the least upside.
This is because JPMorgan Chase has to generate net income growth from segments that will grow at varying rates (commercial and consumer banking will lag the growth of asset management and investment banking).
JPMorgan Chase has had difficulty with generating consistent gains from investment activities (London Whale). However, the loss from the London Whale incident was largely offset by the vast empire of financial services the company has a grip on. This is why a lot of the headlining issues that face the bank have a limited impact on the stock price. Not to mention the diversification of the business helped to keep Jamie Dimon as both the CEO and chairman of the company.
Conclusion
The three banks are likely to generate returns that beat the market average (S&P 500). I believe that the investment banks and asset-management firms (Goldman Sachs, Morgan Stanley) are the hot spot for growth within the financial sector.
The investment banking industry is expected to grow earnings by 18.3% in 2013, with the asset management industry expected to grow earnings by 31.8% over the same period. On the other hand, Goldman Sachs and Morgan Stanley (NYSE:MS) did not provide any guidance for the next quarter. Even without guidance, I believe that these companies will be able to sustain earnings growth as the Dow Jones industrial average (Dow Jones Indices:.DJI) has continued to trend higher into the third quarter.
On the upside, savings and loans have more stability. This means JPMorgan Chase will be less exposed to the volatility of the stock market, but on the downside will generate lower rates of revenue growth. As a result, analysts anticipate JPMorgan Chase to report earnings growth of 13.5% for the 2013 fiscal year.
The article Who Will Profit the Most in the Financial Sector? originally appeared on Fool.com and is written by Alexander Cho.
Alexander Cho has no position in any stocks mentioned. The Motley Fool recommends Goldman Sachs. The Motley Fool owns shares of JPMorgan Chase & Co (NYSE:JPM). Alexander is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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