Morgan Stanley (MS) reported better-than-expected FY4Q21 earnings on Wednesday before the opening bell. On the top line, revenues of $14.524 billion (+6.8% YoY) outpaced the $14.494 billion expected (FactSet). On the bottom line, adjusted diluted earnings per share of $2.08 (+8% YoY) exceeded the $1.91 per share consensus.

On the release, CEO James Gorman commented: "2021 was an outstanding year for our Firm. We delivered record net revenues of $60 billion and a ROTCE of 20%, with stand-out results in each of our business segments. Wealth Management grew client assets by nearly $1 trillion to $4.9 trillion this year, with $438 billion in net new assets. Combined with Investment Management, we now have $6.5 trillion in client assets. Our integrated investment bank has continued to gain wallet share. We have a sustainable business model with scale, capital flexibility, momentum and growth."

Firmwide Metrics

Before digging into the various operating segments, let's take a quick look at some key firmwide metrics. Return on tangible common equity (ROTCE) came in at a very strong 19.8%, outpacing the 19% consensus. The bank's expense ratio — a measure of efficiency that is calculated as total noninterest expenses divided by net revenues - came in at 66%, was nicely below the 68.8% consensus and an improvement versus the 67% level seen in the year-ago period.

Regarding expenses, when asked about management's ability to control them, the team said it benefits from a differentiated business model. Because wealth management advisors and most of the investment banking division are compensated based on what they produce, we don't really see an impact from wage inflation. In other words, when the employees make more money, it doesn't really hit margins because this is a result of them bringing in more money for the firm. We cannot stress how important it is to understand this, especially during this particular earnings season, when last week Goldman Sachs was hit on this expenses front, and that took down Morgan Stanley since they trade together.

Meanwhile, the Common Equity Tier 1 (CET1) capital ratio — a measure of bank capital versus risk-weighted assets and a sign of the bank's ability to endure financial stress — registered at 16.0%, slightly above the 15.4% consensus. Given that the regulatory minimum for this ratio for Morgan Stanley is 13.2%, the firm has plenty of flexibility to invest in the business, support the dividend and continue to buy back shares. In fact, despite issuing 302 million new shares in relation to the E-Trade and Eaton Vance acquisitions, absolute share count actually decreased from 1.81 billion in the end of 2020 to 1.772 billion as of the end of 2021.

Lastly, the bank's tangible book value per share (TBVPS) — a measure of intrinsic liquidation value — came in at $40.91, down from $41.95 in the year-ago period. However, that's slightly ahead of expectations of $40.66 per share.

Segment Results

Starting with 1) Institutional Securities, net revenues of $6.669 billion (-4.3% YoY) came in below the $6.712 billion consensus. Making up that number was investment banking revenues $2.434 billion (+5.7% YoY), equity revenues of $2.857 billion (+12.7% YoY), fixed income revenues of $1.228 billion (-31.4% YoY) and other revenues of $150 million (-56.4% YoY).

Jumping over to 2) Wealth Management, revenues of $6.254 billion (+10.26% YoY) edged out the $6.237 billion consensus. On the call, Gorman commented that "the growth we have seen in 2021 has been unprecedented." Driving the segment was a 24.4% YoY advance in asset management revenues — which is a reflection of higher asset levels resulting from market appreciation and "strong positive fee-based flows." Net interest income was also a positive in the segment, increasing 16.4% YoY thanks to "strong growth in bank lending and higher brokerage sweep deposits." Additionally, the Wealth Management business added net new assets of $438 billion, bringing total client assets under management (AUMs) to $4.9 trillion (+23% YoY).

Finally, on the 3) Investment Management front, revenues of $1.751 billion (+59% YoY) outpaced the $1.65 billion consensus. Driving the results was an 82.4% YoY increase in asset management. Additionally, AUM came in at a record $1.6 trillion, nearly triple what they were 2014 – when Morgan Stanley had finally recovered from the financial crisis, but before its strategy reset and some restructuring.

Capital Returns

On the capital returns front, the firm repurchased 28 million shares in the quarter at an average purchase price of $99.80 per share, resulting in a return of capital to shareholders to the tune of $2.833 billion. Furthermore, the Board of Directors declared a quarterly dividend of $0.70 per share, payable on February 15, 2022 to shareholders of record on January 31, 2022.

Looking Ahead

Morgan Stanley is already off to a good start for 2022, with Gorman opening the call by commenting: "With the early successes of the E-Trade and Eaton Vance acquisitions and the firm's overall momentum, we entered 2022 ahead of plan." Quantifying that, management expects to realize an additional ~$500 million of net interest income in Wealth Management. To help investors better understand the impact of rising rates, Gorman noted that if we were to see a 100 bps parallel shift in the rate curve, Morgan Stanley would expect to deliver another $1.3 billion in revenue.

Additionally, having exceeded recent objectives in 2021 on ROTCE (20% in 2021 vs, 14% to 16% target), the efficiency ratio (66% vs 69% to 72% targeted) and Wealth Management's pre-tax margin (27% vs 26% to 30% targeted), the team took some time to provide new near-term and longer-term objectives. 

On ROTCE, management is upping the ante and now targeting a 20%+ rate of return. Additionally, while the efficiency ratio was already on target, the goal now is to solidify under the 70% level. As for the Wealth Management pre-tax margin, management is now targeting 30%+ over time. Additionally, longer-term, the team is targeting client assets of $10 trillion. 

All in, this was a solid quarter from Morgan Stanley that represents the transformation the bank has gone through in recent years as well as strong expense management. As a result of growing more durable revenue sources and efficiently managing expenses, management has achieved greater sustainable earnings power and will be able to effectively invest in the business while returning capital to shareholders. At ~$95 a share (down ~9% over the past week), we believe this is an incredible buying opportunity, and we certainly have done so. 

Bottom line, let's put it this way: just a couple weeks ago, Morgan Stanley's stock was trading 105$/share with some number of expected earning results. Fast forward one week later, the stock is trading ~95$/share with *much better than expected* earning results. There are two things that drive the stock: i) company's earnings results and ii) macroeconomic conditions that may impact company's earnings results. For i), we just got better than expected earnings results, and bright forecasts; stock is cheaper than before we got those numbers. For ii), expectations for rate hikes have increased, which process would make Morgan Stanley more profitable; the stock is still cheaper than a week ago. There are just too many dislocations between what should happen versus what actually happened here, making this an incredible buying opportunity.