The Zacks Investment Bank sector, which had enjoyed a dream run since mid-2020, now faces a challenging operating environment due to severe macroeconomic and geopolitical factors. This, along with the costs associated with technology upgrades and business diversification efforts, will hurt the finances of industry players.

Yet trading activity, which had normalized after a robust performance during the pandemic era, is again seeing improved performance on heightened market volatility and client activity. Thus, industry players like Morgan Stanley MRS, Raymond James Financial, Inc. RJF and Evercore Inc. EVRs are worth a look despite short-term headwinds.

Description of the industry

The Zacks Investment Bank industry consists of businesses that provide financial products and services that include advisory-based financial transactions to businesses, governments, and financial institutions worldwide. These began as partnership firms focused on initial public offerings (IPOs), secondary market offerings, brokerage, and mergers and acquisitions (M&A). Gradually, companies became providers of a variety of other services, including securities research, proprietary trading, and investment management. Therefore, industry players primarily operate through three product segments – investment banking (comprising mergers and acquisitions, advisory services, and securities underwriting), asset management, and trading and investments (including proprietary trading and brokerage).

3 big trends shaping the future of the investment banking industry

Slowdown in underwriting and mergers and acquisitions: After a blistering performance in 2021, IPO, underwriting (mostly equities) and trading activity has all but come to a screeching halt since the start of this year. The main reasons for the contraction in investment banking (IB) activities are the ongoing conflict between Ukraine and Russia and significant monetary tightening across the world to control runaway inflation. These difficult market conditions cause stock prices to fall and global economic growth to slow, which hurts debt and equity issuance. While the deal pipeline appears healthy, there has been a substantial decline in M&A activity and volumes. Thus, the weakness of the underwriting and advisory activities should harm the growth of the revenues of the players in the sector.

Technology upgrades incur higher costs: Innovative trading platforms and investments in technology and advertising are likely to support the global operations of investment banks. Industry players are focusing on attracting and retaining top talent to build a leadership team and invest in technology to support customers in developing infrastructure and new platforms. Given these efforts, investment banks are likely to face increased technology-related costs, which hurt earnings growth.

Commercial company to provide support: Clients’ trading activity largely depends on macroeconomic and geopolitical conditions. From the beginning of the second quarter of 2021, markets started to normalize and equity markets were less volatile following the extreme volatility experienced in 2020 and the first two months of 2021 due to the uncertainty induced by the coronavirus outbreak. Again, since the beginning of this year, market volatility has increased considerably on several geopolitical and macroeconomic concerns. This helped trading volumes, which, with substantial cash in investors’ hands, could boost trading revenue.

Zacks’ industry rankings point to a bleak picture

The Zacks Investment Bank industry is a group of 17 stocks within the broader Zacks Finance sector. The industry currently carries a Zacks industry ranking of #166, which places it in the bottom 34% of over 250 Zacks industries.

The group’s Zacks Industry Rank, which is essentially the average Zacks Rank of all member stocks, indicates a lackluster near-term outlook. Our research shows that the top 50% of industries ranked by Zacks outperform the bottom 50% by a factor of more than 2 to 1.

The industry’s positioning in the bottom 50% of Zacks-ranked industries is the result of a disappointing earnings outlook for constituent companies overall. Looking at revisions to aggregate earnings estimates, it appears analysts are gradually losing confidence in the earnings growth potential of this group. Over the past year, industry earnings estimates for the current year have fallen 5.9%.

Before outlining a few stocks you may want to consider despite the industry-wide challenges, let’s take a look at recent stock market performance and the valuation picture.

The industry underperforms the sector and the S&P 500

Investment banking industry Zacks has underperformed its sector and the S&P 500 over the past year. While stocks in the sector collectively lost 17.6%, the S&P 500 composite fell 16.4% and the Zacks Finance sector fell 17.3%.

Year-over-year price performance

Industry assessment

One can get a good idea of ​​the industry’s relative valuation by looking at its price-to-book (P/TBV) ratio, which is commonly used to value investment banks due to the large swings in their earnings from quarter to quarter. the other. .

The industry currently has a 12-month P/TBV of 3.12X, above the median level of 2.62X, over the past five years. This compares to the highest level of 3.85X and the lowest level of 1.35X during this period. However, the industry is trading at a huge discount to the broader market, as the 12-month P/TBV ratio for the S&P 500 is 9.36X and the median level is 9.79X.

Tangible Price-to-Pounds Ratio (TTM)

Since financials generally have a lower P/TBV ratio, comparing investment banks with the S&P 500 may not make sense for many investors. But a comparison of the group’s P/TBV ratio with that of the wider sector ensures that the group is trading at a decent discount. The Zacks Finance sector 12-month P/TBV ratio of 4.06X and the median level of 3.85X for the same period are above the respective Zacks Investment Bank sector ratios.

Tangible Price-to-Pounds Ratio (TTM)

3 investment banks to watch

Morgan Stanley: This Zacks Rank #2 (Buy) stock is one of the world’s leading players in the IB sector. The company has offices in 41 countries through which it provides services to businesses, governments, financial institutions and individuals.

You can see the full list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Morgan Stanley’s initiatives to restructure operations and focus more on the Wealth Management and Investment Management segments (as these are less reliant on capital markets) are bearing fruit. The company’s strategic expansion efforts, including the buyouts of Eaton Vance, E*Trade Financial and Shareworks, are moving in this direction. Thus, the overall contribution of the two segments to net sales has increased from 26% in 2010 to 50% in 2021.

While short-term worries will likely hamper financials in the coming quarters, Morgan Stanley’s strong balance sheet, manageable debt levels and investment-grade long-term credit ratings are major tailwinds.

MS has a market cap of $136.5 billion. Over the past 12 months, the company’s shares have fallen 16.3%. The Zacks consensus estimate for 2022 revenue was 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, Florida. The company, together with its subsidiaries, provides financial services primarily in the United States, Canada and the United Kingdom.

RJF has achieved several strategic agreements in recent years, which has also contributed to its expansion in Europe and Canada. In July 2022, it acquired SumRidge Partners, which will strengthen its fixed income capabilities. In June, it completed the acquisition of TriState, while in January, it completed the acquisition of UK-based Charles Stanley Group PLC. These transactions, along with several previous ones, set Raymond James up for growth.

Although the steady increase in spending and the current geopolitical and macro-economic uncertainties have us worried, a strong balance sheet and investment-grade long-term credit ratings from major rating agencies should continue to support growth. Additionally, Raymond James’ robust capital deployments reflect a strong liquidity position and will continue to enhance shareholder value.

With a market cap of $21.6 billion, Raymond James should continue to benefit from its scale and business expansion efforts. Its shares are up 9.4% over the past year. The Zacks consensus estimate for fiscal 2023 earnings was unchanged at $9.61 over the past 30 days.

Pricing and Consensus: RJF

Evercore: This Zacks Tier 3 firm is one of IB’s leading independent global consultancies. It also offers wealth management services. It operates from its offices and subsidiaries in North America, Europe, the Middle East and Asia.

EVR generates the majority of revenue from the IB business. Customer development efforts in consulting solutions and geographic expansion initiatives continue to support revenue growth. Although total adjusted net revenue decreased in 2019 due to lower consulting fees, it also recorded a CAGR of 16.8% over the past four years (ending 2021). Despite several short-term headwinds, the company’s strong backlog and commercial investments will drive IB’s business in the coming quarters.

Although the steady increase in operating expenses and negligible revenue generation from the wealth management business are of concern, Evercore maintains a strong balance sheet and liquidity position. In addition, the company is constantly improving shareholder value through regular capital deployment activities.

EVR has a market cap of $3.1 billion. Over the past 12 months, the company’s shares have fallen 38.3%. The Zacks consensus estimate for current-year earnings was unchanged at $9.66 over the past month.

Pricing and Consensus: EVR

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