Finance

Gillian Tan is a Bloomberg Gadfly columnist covering deals and private equity. She previously was a reporter for the Wall Street Journal. She is a qualified chartered accountant.

Morgan Stanley should relish being the odd one out. 

Like its five bigger peers, the firm on Wednesday posted results that handily beat Wall Street's expectations for its second-quarter earnings. But it bucked a trend that afflicted those five: Morgan Stanley's shares actually bounced higher in pre-market trading on Wednesday, underscoring its achievement of a rare feat: broad-based satisfaction among shareholders. 

Long Road Back
Morgan Stanley's shares have rebounded toward levels not seen since early 2008. An additional $5 billion in planned buybacks should support its valuation.

This time last year, James Gorman, the bank's chairman and CEO, deemed it too early to take a celebratory victory lap over its decision to reorganize its fixed-income trading business (a move it made after shifting its focus toward wealth management). Back then, the unit's revival showed early signs of health through its delivery of more than $1 billion in revenue. A recent Wall Street Journal profile of Morgan Stanley's trading chief Ted Pick reiterated the bank's hesitance to celebrate its burgeoning success: he had been telling associates that the division was "operating with 'omentum'— that is, momentum with an 'm' so small it is invisible." 

It's nice to be humble, but the numbers paint another picture. Morgan Stanley's latest results show the bank blew through $1 billion in fixed-income trading revenue for the fifth consecutive quarter. In doing so, it's been able to better the results of close rival Goldman Sachs Group Inc. for a second straight period.

Morgan Stanley's ability to displace its stalwart rival, in part by taking on more risk, isn't going unnoticed. Even though executives will likely continue to play it down, they've earned the right to some out-of-the-spotlight high-fives and pats on the back. 

It's easy to see why investors are so upbeat: Although there is room for improvement, the bank's return on equity, a key profitability measure, is finally more dependable and once again within management's targeted range. (This quarter it even bested ...you guessed it, Goldman Sachs).

Steadying the Ship
Finally, Morgan Stanley is beginning to achieve stability in the closely-watched metric of return on equity. It has been targeting a range of 9 to 11 percent.
Source: Bloomberg Intelligence

And it's not just the top line -- Morgan Stanley also has kept a watchful eye on expenses. This quarter, its compensation ratio -- traditionally the biggest cost for banks -- fell to a whisker below 45 percent, which itself is a level that Bloomberg Intelligence analysts weren't expecting it to hit until 2018. Investors will be grateful that the New York-based bank has been successfully keeping a lid on non-compensation expenses, too:

Shrewder by the Quarter
Rising revenue and shrinking expenses have enabled Morgan Stanley to best its targeted efficiency ratio of 74 percent. Still, there's room for that figure to be whittled down further.*
Source: Bloomberg Intelligence
*Its closest rival Goldman Sachs has posted an efficiency ratio of 72 percent or lower for the past six quarters

The bank is ticking all the boxes, despite having to operate in the same challenging environment afflicting its rivals -- and it's being rewarded by Wall Street as a result. The stock now trades at a price-to-book-value ratio of 1.2, according to data compiled by Bloomberg, a rightful premium to its five-year historic average. That itself will give Morgan Stanley further bragging rights -- its shares basically no longer trade at a discount to Goldman's.

Playing Catch-up
Morgan Stanley's fixed-income trading business has been on a tear. Its stock may soon best Goldman Sachs on a valuation front, too.
Source: Bloomberg

Whether or not the bank can justify its current valuation, which may well shift higher, will depend on its ability to maintain its 'omentum' not only in fixed-income trading, but across key businesses of equities trading and wealth management, which appear to be bulletproof. For now, it's hard to foresee a halt to its progress. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Gillian Tan in New York at gtan129@bloomberg.net

To contact the editor responsible for this story:
Beth Williams at bewilliams@bloomberg.net