Remainder of '92 may be lean for brokerage firms

Andrew Leckey

September 23, 1992|By Andrew Leckey | Andrew Leckey,Tribune Media Services

The financial markets have had their good days and bad days this year, and it doesn't take much to trigger either of them.

No investor smiles too broadly when the New York Stock Exchange leaps 70 points in one day after the Germans slice XTC their interest rates just a smidge. That's because investors have also experienced down days based on vague worries tied to economic data that's either contradictory or incomplete.

The hair trigger is even more pronounced when it comes to individual stocks, since even a murmur of bad corporate news can send a specific equity tumbling. Pity the poor traders whose business dictates they must buy certain stocks when nobody else is willing to take them. Wall Street specialist firms responsible for making markets in stocks on exchange floors have seen profits plunge in this quirky market.

Yet brokerage firms that do business with the investing public have managed to keep on pulling in new money, more commissions and greater profits. They can thank the average investor, who, finding few worthy investment alternatives, is willing to cope with some uncertainty and volatility to put his money in stocks, bonds and mutual funds.

Drawing in money transferred from low-interest bank accounts, brokerage firms saw second-quarter pretax profits rise 33 percent. This marked the sixth consecutive strong earnings quarter for securities firms, which continued to outstrip expectations. Unfortunately, some analysts believe the gravy train may be about to end.

"The second half of 1992 won't be as good for brokerage firms as the first half, for a cyclical downturn is likely with a 20 to 25 percent earnings decline next year," predicted James Hanbury, analyst with Wertheim Schroder & Co. "This decline still won't be as traumatic as past industry down cycles, for the industry has been trying to keep expenses down by not hiring a lot of additional support staff."

He notes that stocks of brokerage firms, while below their highs, are still priced above their book value. And remember, the future isn't a sure thing.

"There is good industry expense control and profits are reasonably good, but you can't expect next year to keep up with record results of this year," said Lawrence Eckenfelder, analyst with Prudential Securities. "The industry just might run out of gas."

Alison Deans, analyst with Smith Barney, Harris Upham & Co., agrees it's difficult to imagine the industry becoming "more robust," but she still considers brokerage stocks attractive. There might even be some additional kick if merger and acquisition activity picks up.

"The past several years, the brokerage industry has changed from emphasizing gains in market share to emphasizing profitability and cost controls," said Ms. Deans. "That's positive for the future."

Samuel Liss, analyst with Salomon Brothers, notes that these stocks peaked in price last February. Since then, the market has discounted their record earnings as "to-be-expected."

"I don't have any brokerage stocks on my buy list because I believe the earnings comparisons will be extremely difficult in the coming year," said Mr. Liss. "To have real gains in these stocks, people must first be convinced that next year's earnings can't collapse."

For long-term investors who envision the more optimistic path for these stocks, there are a number of choices among well-managed firms whose shares are selling at reasonable prices.

Stock of Merrill Lynch is recommended by Ms. Deans and Mr. Hanbury. This giant, with its dramatic ability to gather retail assets and remain custodian of large sums, should continue to do so in the future. It has an enormous sales staff. An average annual 15 percent return on equity is quite likely.

The stocks of Morgan Stanley and Bear, Stearns in institutional investing are recommended for purchase by Ms. Deans and rated "above average" by Mr. Hanbury. Morgan Stanley, top-quality and probably the best-run firm, is profitable and flexible. Run like a partnership, Morgan Stanley insiders own 40 percent of its stock. Bear, Stearns, also well-managed, always makes strong payouts to shareholders and has initiated new cost-cutting.

In addition, the reasonably priced stock of Salomon Brothers Inc. is suggested by Mr. Hanbury.

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