Uncertainty remains within Brokers Morgan & Goldman

Last of a dying breed? Morgan Stanley (MS) & Goldman Sachs (GS) remain Wall Street's 2 independent brokerage houses, and for that fact, their shares are being sold off heavily day in and day out. Despite the fact that both companies beat reduced earnings expectations for the quarter, they are being lumped into the same selling frenzy as their industry com padres due to their heavy reliance on leveraged investments.

Goldman profit fell 70% year-over year but the company still managed to make ends meat. The yearly comparisons are not pretty considering Goldman's record 2007 financial year. $810Million in profit ($1.81/share) vs. $2.81Billion ($6.13/share) last year. Overall revenue was down also from $12.3Billion to $6.04Billion.

Morgan Stanley, which had its own set of difficulties over the year reported profit that fell 3% year over year, $1.43Billion vs $1.47Billion, which translates into $1.32/share this quarter. With net revenue reaching $8Billion, a 1% year over year increase, Morgan showed it can still deliver results, however the pressure on the company to make a deal with a bank is staggering.

The old leverage issue again, as Investors feel the only way to shore up capital and assure broker survival is to pair up with a bank and the giant vault of deposits that go along with it. When Merrill Lynch (MER) made the deal with Bank Of America (BAC), followed by Lehman Brothers (LEH) bankruptcy, both of which followed JP Morgan Chase (JPM) rescue of Bear Stearns the Street was down to 2 stand-alone investment houses.

The rumor-mill has run wild of late regarding Morgan, with reports of conversations with Citigroup (C), Wachovia (WB) and China Investment Corporation, which if done would leave Goldman Sachs as the sole big name brokerage left on Wall Street. Investor publications have held a positive opinion so far on BAC's deal for Merrill, so for Citigroup or Wachovia picking up Morgan Stanley on the cheap would also feel like a win.

However, in the turbulent times that are continuing, with a financial crisis unseen in most Investors lifetimes, the "Let's make a deal" talks are very cautious to say the least. If Morgan does join with a bank, and signs are pointing more likely recently that they will, Goldman will find itself in a unique position, having its main competitors under the corporate shells of some of the largest financial institutions in the country. The optimist finds that this will allow Goldman to thrive as the economy strengthens and underwriting and M&A advisory work become more prevalent, but the pessimist finds a single brokerage model struggling to survive in these economic tidal waves.

As Markets see-saw between down 400 point and up 400 point days, the successful trade is being on the optimist/pessimist part of the see-saw on the correct day. Lately though, the pessimism has run rampant.





Disclosure: Author owns GS, C

GS or MS: Battle Of The Banks

In the truest sense of the old-school type Battle of the Bands, where local Garage hopefuls filled stages to compete for the attention of, and possible employment from a single club or record label owner, I present a Battle of the Investment Banks.

With Bear Sterns (BSC) being the latest to fall like a 100 year old Redwood doing battle with the sub-prime market. Reports have surfaced over the last week that a couple big hedge funds inside the firm that were heavily invested in this industry are now virtually worthless. Does the investment banking investor have any hope out there?

Well, there are choices aplenty in this space such as Goldman Sachs (GS), Morgan Stanley (MS), Lehman Brothers (LEH) or Merrill Lynch (MER), along with several smaller firms all fighting for business and your investment dollar. Not to mention that the big brick-and-mortar banks are expanding heavily into the investment sector.

Taking the stage here and now surely wont be a local teenager with a new birthday present electric guitar, as we're looking at and comparing the cream of the crop in the investment banking world. Goldman Sachs and Morgan Stanley are the two biggest firms by market cap and for good reason, both companies are very good at what they do, and that's attract big clients, charge huge fees, and make money off every kind of investment imaginable. Have you ever heard of Weather Derivatives? It's where people in the marketplace can place bets on how many days it'll be higher or lower than the average temperature in a given month. You've never invested in something like this? Didn't think so, but guess what, these firms do!

So which one is better now and years from now? First to the stage Goldman Sachs. (Come on, you're telling me that wouldn't make a great band name)
The stock has fallen from a peak of $234 to $205 as it's been sideswiped, like everything else in the sector by this risky-mortgage mess. More often than not it is credited as being the best investment bank in the world and it sits with a trailing P/E of 9.5! A single digit P/E for a company that's earning and growing like Goldman Sachs. This rock star sports a healthy estimated Price to growth ratio of 0.7.

Goldman is so good at what it does but seemingly analysts are confounded at exactly what it does and how it goes about doing it. Yes Goldman has booked tremendous gains over the last year in some early Chinese investments but it's investing in these kinds of things all the time and people are surprised by the success. The nature of some of Goldman's trading operations make it seem like that part of the business is being run like one large hedge that can crash and burn on a bad bet or two but I think professionals that cover this company are missing the point. These are the smartest market people on the planet and they have backup plans that have backup plans. There's risk taking and then there's too much of a good thing, that's bound to crumble, just ask those Bear Sterns funds.

Goldman appears to be masterful at managing its internal risks but they have yet to fully be rewarded for it. The run up of the stock from the 150s to the 220s last year and early into this year should've only been the beginning however a wall was hit and the shares are tumbling back to the 200s. Opportunity? I think so!

Let's look at the other company. Morgan Stanley. If you thought Goldman's fundamentals were impressive how about Morgan sporting a P/E of 7.7 and a Price to growth of 0.6. Now Morgan Stanley notoriously went through step after step of cost-cutting and re-tinkering over the last 12 months in order to boost it's shareholder value and it seemed to have spark a turnaround in the business as well. But it also was hit hard falling from a high of 76 to it's current levels around $67/share. As far as businesses go, Morgan Stanley would seem more transparent to the average investor as they have clearly drawn lines for its business units and even are a player in the credit card world with their Discover brand. However, that has been an area of contention for the company as many feel selling that business unit would ultimately lead to more value long term and as such the company announced June 30th as the day it would in fact spin off the Discover business resulting in a $14/share payout to shareholders.

Is there an opportunity here also? Yes, however here is why I believe Goldman Sachs is the better play now and for the longer term.
Both companies brought in revenues of around $39Billion over the last year, however Goldman earned a Billion more ($10B v $9B). Goldman clearly is able to more efficiently turn a profit at a slightly higher margin rate. Here's the kicker though, Morgan Stanley employs 55,000 people, while only 30,000 work for Goldman Sachs.

Not only is Goldman earning more from the same amount of revenue, they are doing it almost half the personnel! So is it likely that in the years going forward Morgan Stanley is going to go through a massive layoff spree to bring it's personnel down so it can compete with Goldman in terms of profitability? No. What does seem more likely though, is that as both firms grow Goldman should have more room to expand and hence earn more money running it's top notch trading operations and hence have more opportunities to lure business away from other firms.

Both firms look prime for a rebound later in the year however I think you'll find Goldman's songs at the top of charts more consistently than Morgan's.

Disclosure: Author is long GS and holds no position in MS