Morgan Stanley vs. Goldman Sachs

Over the last few years, it was almost taken for granted that Goldman Sachs GS was the cream of the crop when it came to investment banks. Well, after its respective earnings announcements this past week, Morgan Stanley MS outdid its rival. There are headlines going around like, “Morgan Stanley Outshines Goldman Sachs in Trading.” The one place this was apparent was in equity trading where Goldman Sachs had net revenue of $235 million compared to $1.4 billion for Morgan Stanley.  Morgan Stanley also seemed to outperform in investment banking.

In my opinion, one quarter does not mean Morgan Stanley has overtaken Goldman Sachs as the best investment bank in the world. GS still has a market cap that far exceeds it. However, it does beg the question, “Which one is the better investment over the next year?”  There are some points that are in Morgan Stanley’s favor.

First, it trades on a slightly lower PE (to consensus 2010 estimates) despite the fact a large part of its revenues come from its Morgan Stanley Smith Barney brokerage business. Those revenues tend to be more stable than proprietary trading, and stocks typically can get a higher P/E for that stability.  Second, as mentioned above, over the previous quarter it was Morgan Stanley who traded more profitably. And finally, what is the fallout from the SEC’s lawsuit and settlement against Goldman? The $550 million dollars is almost irrelevant.  The big question is whether or not customers view their relationship with GS differently.  Are they more apt to shop their business elsewhere because they are worried about this conflict at GS?  Honestly, I think this conflict exists at all the big financial institutions; the perception that it is a bigger problem at GS is the concern.  Since there are only a handful of players in these markets Morgan Stanley would benefit if Goldman lost market share.

What about GS?  Despite the issues listed above, its track record for trading success extends over years if not decades; one quarter’s results are somewhat meaningless in the big picture.  They were one of the few shops to get through the biggest financial crisis in 70 years without massive losses.  Also, the cloud of the SEC investigation is now behind it.  Just getting themselves out of the headline s on a daily basis probably helps them in their dealings with customers.

This will be interesting to watch.  Customers can create options strategies that play one off of the other.  For example, you could buy calls in one, and you could sell calls in the other. The thought being if you did it correctly the stock you were long calls in would outperform to the upside and gain more value.

There are a few caveats to doing this: one is you would have to be approved to sell naked options, another is that it probably would take a decent amount of capital to have that short.  In addition, the risk /rewards of each strategy are very different.  The maximum risk to buying calls is the premium paid and the reward can be unlimited above the strike purchased.  For selling calls, the maximum risk is unlimited above the strike sold and the maximum reward is limited to the premium received.  Finally, you would have to understand how many contracts of each you would trade since there is such a difference in price.

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