SIVY ON STOCKS from money.com
May 2, 2001

A bounce for the brokers

Stocks such as Goldman Sachs, Merrill Lynch, and Morgan Stanley were up at
least 5 percent on Wednesday -- and appear poised for even bigger gains.

By Michael Sivy

Most of the people I know are bearish on the shares of the company they
work for. Particularly when business conditions are as difficult as they
are right now, employees tend to focus on the short-term problems their
companies are facing and ignore the long-term fundamentals.

Perhaps that's the explanation for why analysts have recently been
downgrading brokerage stocks. They look around their offices and see
depressed profits and layoffs. Merrill Lynch's earnings fell 21 percent in
the first quarter, for instance, as commissions declined 30 percent,
trading revenue fell 15 percent and underwriting revenue dropped more than
6 percent. Things are so bad that Merrill Lynch and other major firms are
planning to slash their head counts -- by attrition in some cases and
outright layoffs in others.

But those short-term problems mask the fundamentals that long-term
investors should be paying attention to. At the most basic level,
brokerages are proxies for the stock market, so if you expect a resumption
of the bull market in the near future -- as I do -- you have to like the
sector.

And the fundamentals figure to keep improving. The economy should receive
an enormous boost over the next nine months from the Federal Reserve's
recent interest-rate cuts. And a large tax cut will encourage consumer
demand. Plus, concessions to Congressional Democrats that allow for higher
government spending will add further stimulus. Finally, potential Social
Security reform that permits some form of privatization would be a direct
benefit to financial-services firms.

The stock market has already recognized what the brokerages' own analysts
haven't. Stocks of the leading brokerages were up 5 percent on Wednesday,
and many have rallied at least 25 percent from their 52-week lows.

Still, these shares are hardly overvalued. Even after Wednesday's rally,
the stocks are anywhere from 15 to 35 percent below their highs of the past
seven months. Moreover, they still trade at less than 18 times estimated
earnings for the current year. That isn't much given their projected
long-term earnings growth of 13 percent or more.

Among the leaders in the group, Goldman Sachs [GS], with a 13 percent
growth rate, closed Wednesday at $98 a share for a 17 P/E; Merrill Lynch
[MER], 13 percent growth, traded at $67 for a 17.5 P/E; and Morgan Stanley
Dean Witter [MWD}, 14 percent, closed at $66.50 for a 16 P/E.

Investors might also want to consider A.G. Edwards [AGE] as an undervalued
takeover play. The leading independent brokerage based outside of New York,
A.G. Edwards of St. Louis trades at $43 for a P/E of less than 14. The
trend toward financial services behemoths threatens to chip away at
Edwards' market share. But industry consolidation could also make Edwards a
takeover target, not only for major brokerages but also for the big banks.
Whether the stock is taken over or not, it's cheap based on fundamentals --
especially since it got up to nearly $58 a share when takeover rumors
heated up last summer.

###

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