Morgan Stanley is worth $40

I just bought some shares of Morgan Stanley on Friday which may surprise you given my comments about Goldman Sachs in prior posts.

But before I get into that, I had been selling some stock and my cash position was up to 15% of my portfolio. I was not unhappy with this position given my view that the market is fairly valued between 1000 and 1050 on the S&P500. The sells reflected some profit taking as well as an admission that I was wrong. For profit taking, I sold some of my Amerigon and Shutterfly shares which were purchased in March. I also sold Greenhill which I have written about before. The stock went up to over $91 and my price target was about $100 by the end of 2010. That only left me with a 7% compounded annual return to my price target, so I decided to sell and look for other ideas. I also sold my shares of Monsanto, which I had owned since last fall. I bought this stock without thinking very carefully about the valuation. The company's value proposition was very attractive to me and I bought some shares. As I re-evaluated the stock recently, I decided that the growth assumptions needed to justify the current price would be very hard for the company to beat. I sold and took a 30% loss as a result of my error.

I continue to be bullish longer term however and have been trying to find stocks that I think will perform well in an anemic recovery, which is the environment I expect to be investing in for the next two years at least. Morgan Stanley is one of the companies that I think can fulfill that role.

But why buy Morgan Stanley and sell Greenhill? Aren't they exposed to the same drivers? The answer is that they are exposed to a lot of the same drivers and I am aware of the possibility that Greenhill might go up much more than I think it should. Morgan Stanley is not the pure-play on the M&A cycle that Greenhill is, so investors are less likely to flock to it when looking to play that specific theme. However, Morgan Stanley is cheap and more diversified. Greenhill has already had a big run based on anticipation.

My valuation work suggests that Morgan Stanley is worth about $40 right now, but it trades under $30. That $40 intrinsic value should rise over time as the economy, M&A market, and broader markets go up. So I think there is 33% upside to intrinsic value and I think this is a company and stock that will have rising value to investors over the next several years.

Morgan Stanley has not come out of the recent crash with the same cache that Goldman and JP Morgan have. As the recovery fully sets in, I expect that sentiment gap between GS/JPM and the rest of the sector to narrow.

Regarding risk, I watched Bear, Lehman and Merrill fail to varying degrees and watched as Morgan Stanley and Goldman teetered on the edge for a few months. I also understand that we were watching a credit market that collapsed, intersecting with business models that had become increasingly leveraged and dependent on the credit markets. The good news is that I doubt we will see either MS or GS in a similar position for a very long time. While GS is expensive and almost universally adored, MS has almost identical drivers but is much cheaper. Right now, the credit market is comfortable supporting GS and MS largely because they are both bank holding companies and have the Fed as a backstop. While I think it is a joke to argue that MS and GS are banks, I also think the Fed will keep the status quo until the credit market is willing to fund them alone. It seems very unlikely that they will risk causing another scare right now given the fragile state of the markets and confidence. Basically, I am investing based on the belief that IF Morgan Stanley fails, it will be during the next crash. Since I think we are just coming off the last crash, I think the stock will outperform the markets for over the next 2-5 years.