The Zacks Investment Bank industry, which had been having a dream run since mid-2020, is now facing a challenging operating backdrop due to serious macroeconomic and geopolitical factors. This, along with costs related to technological upgrades and business diversification efforts, will hurt the industry players’ financials.
Yet, the trading business, which had been normalizing after a robust performance during the pandemic era, is again witnessing improved performance on heightened market volatility and client activity. Hence, industry players like Morgan Stanley MS, Raymond James Financial, Inc. RJF and Evercore Inc. EVR are worth a look despite near-term headwinds.
The Zacks Investment Bank industry consists of firms that provide financial products and services that include advisory-based financial transactions to corporations, governments and financial institutions across the globe. These started as partnership firms focused on initial public offerings (IPOs), secondary market offerings, brokerage and mergers and acquisitions (M&As). Gradually the companies have evolved into providers of various other services, including securities research, proprietary trading and investment management. Therefore, the industry players work mainly through three product segments — investment banking (comprising M&As, advisory services and securities underwriting), asset management and trading and principal investments (consisting of proprietary and brokerage trading).
3 Major Trends Shaping the Future of Investment Bank Industry
Slowdown in Underwriting and M&As: After a blockbuster performance in 2021, IPO, underwriting (mainly equity) and deal-making activities have almost come to a grinding halt since the beginning of this year. The primary reasons for the shrinking investment banking (IB) activities are the ongoing Ukraine-Russia conflict and significant monetary tightening across the globe to control raging inflation. These challenging market conditions are leading to a plunge in stock prices and slowing global economic growth, thereby hurting debt and equity issuances. While the deal pipeline looks healthy, there has been a substantial decline in M&A activity and volumes. Thus, subdued underwriting and advisory businesses are expected to hurt industry players’ revenue growth.
Technological Upgrades Lead to Higher Costs: Innovative trading platforms and investments in technology and advertising are likely to support the overall operations of investment banks. The industry players are emphasizing attracting and retaining the best talent for building a leadership team and spending on technology to support clients with infrastructure development and new platforms. Given these efforts, investment banks are likely to face increasing technology-related costs, thereby hurting the bottom-line growth.
Trading Business to Offer Support: Client activity in the trading business largely depends on the prevalent macroeconomic and geopolitical conditions. From the beginning of second-quarter 2021, markets began to normalize and equity markets were less volatile following the extreme volatility recorded in 2020 and the first couple of months of 2021 due to the coronavirus outbreak-induced uncertainty. Then again, since the beginning of this year, market volatility has significantly increased on several geopolitical and macroeconomic concerns. This has helped trading volumes, which along with substantial cash in the hands of investors, might boost trading income.
Zacks Industry Rank Indicates a Grim Picture
The Zacks Investment Bank industry is a 17-stock group within the broader Zacks Finance sector. The industry currently carries a Zacks Industry Rank #166, which places it in the bottom 34% of more than 250 Zacks industries.
The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates dull near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperform the bottom 50% by a factor of more than 2 to 1.
The industry’s positioning in the bottom 50% of the Zacks-ranked industries is a result of a disappointing earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are gradually losing confidence in this group’s earnings growth potential. Over the past year, the industry’s earnings estimates for the current year have moved 5.9% lower.
Before we present a few stocks that you may want to consider despite industry-wide challenges, let’s take a look at the industry’s recent stock market performance and valuation picture.
Industry Underperforms Sector and S&P 500
The Zacks Investment Bank industry has underperformed its sector and the S&P 500 over the past year. While the stocks in the industry have collectively lost 17.6%, the S&P 500 composite has declined 16.4% and the Zacks Finance sector fell 17.3%.
One-Year Price Performance
One might get a good sense of the industry’s relative valuation by looking at its price-to-tangible book ratio (P/TBV), which is commonly used for valuing investment banks because of large variations in their earnings results from one quarter to the next.
The industry currently has a trailing 12-month P/TBV of 3.12X, above the median level of 2.62X, over the past five years. This compares with the highest level of 3.85X and the lowest level of 1.35X over this period. However, the industry is trading at a huge discount when compared with the market at large, as the trailing 12-month P/TBV ratio for the S&P 500 is 9.36X and the median level is 9.79X.
Price-to-Tangible Book Ratio (TTM)
As finance stocks typically have a lower P/TBV ratio, comparing investment banks with the S&P 500 may not make sense to many investors. But a comparison of the group’s P/TBV ratio with that of the broader sector ensures that the group is trading at a decent discount. The Zacks Finance sector’s trailing 12-month P/TBV ratio of 4.06X and the median level of 3.85X for the same period are above the Zacks Investment Bank industry’s respective ratios.
Price-to-Tangible Book Ratio (TTM)
3 Investment Banks to Keep an Eye On
Morgan Stanley: This Zacks Rank #2 (Buy) stock is one of the leading global players in the IB business. The company has offices across 41 countries through which it offers services to corporations, governments, financial institutions and individuals.
You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
Morgan Stanley’s initiatives to restructure operations and more focus on Wealth Management and Investment Management segments (as these are less dependent on the capital markets) are bearing fruits. The company’s strategic expansion efforts, including the buyouts of Eaton Vance, E*Trade Financial and Shareworks, are steps in this direction. Thus, both segments’ aggregate contribution to net revenues jumped from 26% in 2010 to 50% in 2021.
While near-term concerns will likely hamper financials in the next few quarters, Morgan Stanley’s solid balance sheet, manageable debt level and investment-grade long-term credit ratings are major tailwinds.
MS has a market cap of $136.5 billion. Over the past 12 months, shares of the company have declined 16.3%. The Zacks Consensus Estimate for 2022 earnings has remained unchanged at $6.69 over the past 30 days.
Price and Consensus: MS
Raymond James: This Zacks Rank #3 (Hold) stock is a diversified company based in St. Petersburg, FL. The company, along with its subsidiaries, provides financial services mainly in the United States, Canada and the U.K.
RJF has accomplished several strategic deals over the past years, which has also helped its expansion into Europe and Canada. In July 2022, it acquired SumRidge Partners, which will boost its fixed income capabilities. In June, it concluded the acquisition of TriState, while in January, it closed the acquisition of U.K.-based Charles Stanley Group PLC. These deals, along with several past ones, poise Raymond James well for growth.
Though steadily rising expenses and current geopolitical and macroeconomic uncertainties make us apprehensive, a strong balance sheet and investment-grade long-term credit ratings from leading credit rating agencies are likely to continue supporting growth. Also, Raymond James’ robust capital deployments reflect a solid liquidity position and will keep enhancing shareholder value.
With a market cap of $21.6 billion, Raymond James is expected to continue benefiting from its scale and business expansion efforts. Its shares have rallied 9.4% over the past year. The Zacks Consensus Estimate for fiscal 2023 earnings has remained unchanged at $9.61 over the past 30 days.
Price and Consensus: RJF
Evercore: This Zacks Rank #3 company is a premier global independent IB advisory firm. It also offers wealth management services. It operates from its offices and affiliates in North America, Europe, the Middle East and Asia.
EVR generates the majority of revenues from the IB business. Efforts to boost its client base in advisory solutions and geographical expansion initiatives continue to support revenue growth. Though total adjusted net revenues declined in 2019 due to lower advisory fees, the same witnessed a CAGR of 16.8% over the last four years (ended 2021). Despite several near-term headwinds, the company’s strong backlog and business investments will drive IB business in the upcoming quarters.
Though steadily rising operating expenses and negligible revenue generation from the wealth management business are concerns, Evercore maintains a solid balance sheet and liquidity position. Also, the company consistently enhances shareholders’ value with steady capital deployment activities.
EVR has a market cap of $3.1 billion. Over the past 12 months, shares of the company have declined 38.3%. The Zacks Consensus Estimate for ongoing-year earnings has remained unchanged at $9.66 over the past month.
Price and Consensus: EVR
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