- Morgan Stanley reports Q1 earnings on Apr. 14
- The 3-month total return is -18.5%
- The Wall Street consensus rating is bullish, with expected 12-month return of almost 30%
- The market-implied outlook is bullish to mid-2022 and slightly bullish to early 2023
Morgan Stanley (NYSE:MS) reports Q1 results on Apr. 14. For the past 7 quarters, the global financial services player has beaten EPS expectations. However, over the past 3 months, there have been 11 downward earnings revisions which has resulted in the shares sliding 18.5%.
Rising interest rates tend to boost bank earnings, but Morgan Stanley’s focus on wealth management is likely to suppress earnings because Asset Under Management (AUM) fees will have fallen as stock markets declined. Falling equity markets have also resulted in a drop in revenues associated with IPOs and other capital-raising activity.
Shares reached a 12-month high closing price of $108.73 on Feb. 9, 2022, but have subsequently fallen by 22.2% to the current level. Even after this decline, 3-, 5-, and 10-year total returns are impressive (25.7%, 16.8%, and 17.7% per year, respectively). The 12-month total return is 7.9%, as compared to 7.5% for the US equity market index.
With a P/E of 10.46, MS has a reasonable valuation. The dividend yield is 3.33%, and the trailing 3-, 5-, and 10-year dividend growth rates are 28.7%, 26.7%, and 28.5%, respectively.
On Sept. 29, 2021 the shares were trading at $105.15 and I assigned a buy rating. At that time, the Wall Street consensus outlook was bullish, although the share price was about 2% above the consensus 12-month price target. The valuation looked reasonable. In addition, the implied consensus outlook calculated from options trading, the market-implied outlook, was bullish to early 2022 and neutral to mid-2022.
For readers who are not familiar with the concept of using options prices to build a consensus outlook, a brief explanation is needed. The price of an option on a stock reflects the market’s consensus estimate of the probability that the stock price will rise above (call option) or fall below (put option) a specific level (the option strike price) between now and when the option expires. By analyzing the prices of put and call options at a range of strike prices, all with the same expiration date, it is possible to calculate a probabilistic price forecast for the stock that reconciles all of the options prices. This is the market-implied outlook and represents the consensus view expressed by buyers and sellers of options. For readers who want a deeper explanation than is provided here and in the previous link, I recommend this excellent monograph from the CFA Institute (available at no cost).
MS is now substantially below the trailing 12-month high from early February, so I have updated the market-implied outlook and compared this with the current Wall Street consensus outlook.
Wall Street Consensus Outlook for MS
E-Trade calculates the Wall Street consensus outlook for MS by aggregating the views of 11 ranked analysts who have published rating and price targets over the past 90 days. The consensus rating continues to be bullish and the consensus price target is $105.11, 24.7% above the current share price.
Source: E-Trade
Investing.com calculates the Wall Street consensus using ratings and price targets published by 28 analysts. The consensus rating is bullish and the consensus 12-month price target is 26.31% above the current share price.
Source: Investing.com
The consensus 12-month price targets are slightly higher than they were when I last examined MS. The vast majority of the expected gains are due to the decline in the share price in recent months. In other words, the Wall Street consensus outlook suggests that the shares are oversold.
Market-Implied Outlook for MS
I have calculated the market-implied outlooks for the 2.2-month period from now until June 17, 2022 and the 9.3-month period from now until Jan. 20, 2023, using the prices of options that expire on these two dates. I selected these specific expiration dates because options expiring in June and January tend to be among the most actively traded and to provide a view to the middle of 2022 and through the end of the year.
The standard presentation of the market-implied outlook is a probability distribution of price return, with probability on the vertical axis and return on the horizontal.
Source: Author’s calculations using options quotes from E-Trade
The outlook for the next 2.2 months is tilted to favor positive returns, with the maximum probability outcome corresponding to a price return of +3.4%. The distribution is negatively skewed, with higher probabilities of large-magnitude losses than gains. The probability of having a return of -30% is more than twice the probability of having a return of +30%, for example. The expected volatility calculated from this distribution is 36% (annualized). There is some evidence that stocks with negative skewness tend to outperform those with positive skewness.
To make it easier to directly compare the probabilities of positive and negative returns, I rotate the negative return side of the distribution around the vertical axis (see chart below).
Source: Author’s calculations using options quotes from E-Trade
This view shows that the probability of positive returns are consistently higher than the probabilities of negative returns across a wide range of the most probable outcomes (the solid blue line is above the dashed red line on the left half of the chart above). The probabilities of large-magnitude losses are higher than for those of large-magnitude gains, but the overall probabilities of these outcomes is low. This is a bullish outlook for MS for the next 2.2 months.
Theory suggests that the market-implied outlook is expected to have a negative bias because risk-averse investors tend to overpay for downside protection (put options). While this bias cannot be directly measured, the potential for this effect makes the market-implied outlook for the next 2.2 months look even more bullish.
The market-implied outlook for the 9.3-month period until Jan. 20, 2023 has closely matching probabilities of positive and negative returns (the solid blue line and the dashed red line are very close to one another. Because of the expected negative bias, this type of market-implied outlook is interpreted to be slightly bullish. The expected volatility calculated from this distribution is 34%.
Source: Author’s calculations using options quotes from E-Trade
The market-implied outlook for MS to the middle of June is bullish and the outlook to early 2023 is slightly bullish. The expected volatility is quite stable at 36% to mid-2022 and 34% to early 2023.
Summary
Morgan Stanley is currently more than 20% below its 12-month high close from early February. Although rising interest rates tend to be a tailwind for banks, faltering equity markets will have a disproportionate impact on its earnings compared to peers.
The Wall Street consensus outlook remains bullish and the consensus 12-month price target implies a total return of 28-29%. So, from this perspective, the shares appear to have been oversold on earnings fears.
As a rule of thumb for a buy rating, I want to see an expected total return that is at least half the expected volatility (about 35% in the market-implied outlooks) and MS looks attractive on this basis, even with a significant discounting of the analyst outlook.
The market-implied outlook to the middle of June is bullish, and the outlook to January of 2023 is slightly bullish, so I am maintaining my bullish rating.