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On Mar 11, 2013, we reaffirmed our Neutral recommendation on Morgan Stanley (MS - Analyst Report) based on its better-than-expected results, overall growth initiatives (through organic and inorganic means) and clearance of Federal Reserve’s Stress Test. However, elevated cost structure, stringent regulatory landscape and sluggish economic recovery is likely to mar its profitability in the near to mid term.

Why the Neutral Stance?

Though Morgan Stanley’s earnings were substantially better than the year-ago loss, it had marginally exceeded the Zacks Consensus Estimate. The decent quarterly results for Morgan Stanley were attributable to top-line growth, partially offset by continued high operating expenses.

Further, in the past 30 days, a few estimates have moved up, resulting in only a 0.5% improvement in the Zacks Consensus Estimate for 2013. Estimates for 2014 have also improved by 1.2% over the same period. In addition, over the past 4 quarters, the average earnings surprise has been a decent 20.3% for this Zacks Rank #3 (Hold) stock.

Morgan Stanley is significantly diversifying its footprint and product portfolio, enjoying top-tier global capital markets authorization and solid international prospects in the long term through added consistency from private clients and asset management units. Also, the company continues to expand inorganically.

It has cleared the latest rounds of Stress test; therefore, it is likely that following the prioritized acquisition of remaining stake in Morgan Stanley Wealth Management, the company will enhance dividend payments and restart share buybacks.  

Yet, for Morgan Stanley, increasing expenses remain a concern. Though operating expenses in 2012 decreased nearly 2% from 2011, we anticipate it to remain high in the near term, as restructuring initiatives announced to reduce costs are expected to take time to show the positive impact. Further, Morgan Stanley’s profitability is expected be affected by the financial reform law due to higher costs and fee restrictions.

Additionally, slow economic recovery will create cyclical pressures in the weak commercial real estate sector, increasing concerns over the near term.

Other Stocks to Consider

Other stocks that are performing well and are worth considering in the same sector include Evercore Partners Inc. (EVR - Snapshot Report), Knight Capital Group, Inc. (KCG - Snapshot Report) and Piper Jaffray Companies (PJC - Snapshot Report). All these stocks carry a Zacks Rank #1 (Strong Buy).

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