Brokerage Stocks: Casualties Of Market Slump
By Daniel Dunaief
CNBC.com Financial Reporter
Dec 28, 2000 10:00 AM
As 2000 began, the economy and the markets looked invincible, even after a few rate hikes from the Federal Reserve. The Nasdaq continued its historic climb to record territory, and companies like Morgan Stanley Dean Witter & Co. {MWD, News, Boards} and Goldman Sachs & Co. {GS, News, Boards} were right in the center of a technology-giddy market, helping to bring public a seemingly endless stream of companies that would make investors and bankers rich.
Indeed, back in those heady days, Merrill Lynch & Co. {MER, News, Boards} was punished with a lower price to earnings multiple than Morgan Stanley and Goldman Sachs because it didn't have as large a share of the New Economy investment-banking business.
Now, these huge planets are back in alignment: Merrill Lynch's shares trade at about 16 times expected 2001 earnings, which is just above the 15.6 multiple for Morgan Stanley and below the 16.2 for Goldman Sachs.
But their horoscope does not look favorable. They are all seeing declines in trading and stock and bond underwriting that, although expected amid the market sell off, have hurt profits. And there is worse to come: On the heels of quarterly earnings reports from Morgan and Goldman last week, analysts cut estimates for 2001. Morgan Stanley fell short of the consensus estimate for the second straight quarter, while Goldman Sachs beat the estimate, but reported expenses that were higher than some analysts expected.
The reasons for profit concerns are not obscure. Continued uncertainty in the markets threatens venture capital, investment banking, and trading revenue, analysts say. Next week, investors will get a glimmer of how these factors are affecting some of the next-tier investment banks when Lehman Brothers Holdings {LEH, News, Boards} and Bear Stearns Cos. {BSC, News, Boards} report earnings.
Deep Discounts
As rough as the market slump has been for the investment banks, it's been even tougher for the discount brokerage firms such as Charles Schwab Corp. {SCH, News, Boards}, Ameritrade Holding Corp. {AMTD, News, Boards}, and E*Trade Group {EGRP, News, Boards}. These firms are all seeing a pullback by retail customers who have seen the value of their holdings decline as the Nasdaq Composite Index plunged more than 50% from its high earlier this year.
Shares of Ameritrade and E*Trade are down 65% and 72%, respectively, from the beginning of the year.
One-year comparison chart of Ameritrade Holding Corp. & E*Trade Group.
In addition to suffering from the cyclical issues that are hurting the big guys, these companies are getting slammed because of rising skepticism over whether online trading will be an industry unto itself or merely a feature of the brokerage business. "The Internet is a tool, it's not a business model," says Mark Constant, an analyst at Lehman Brothers Holdings. "If you look back a year ago, a lot of people believed that the E*Trades and Ameritrades would take over and that asset managers and full service brokers were dead. That myth has been disproven."
And the longer the Nasdaq languishes, the worse the outlook for the online upstarts. "We've taken Ameritrade's estimates from 4 cents a share gain to 5 cents a share loss" for the coming quarter, says Gerard Cronin, an analyst at McDonald Investments Inc. And even Schwab, the discount giant which has fared better than the pure plays in online trading, is coming under pressure.
Cronin cut his estimate for 2001 to 68 cents a share from 73 cents recently and, he says, that might not be the last time he reduces his estimates.
"Is there more to come? If the market continues to go down, absolutely," he says.
And that, as they say, is the rub. It is the fear of a further market sell off and a slowing economy that has made investing in companies that investors once thought could grow to the sky so precarious. In anticipation of a more difficult climate ahead, Schwab has taken the unusual step of cutting its officers' salaries in January and February and reducing 2001 first-quarter bonuses. The company also asked its employees to take some voluntary unpaid leave between January 1st and March 31st.
One-month performance of Goldman Sachs
That paints a pretty grim picture, at least for the discount brokers. For now, says Cronin, any investment in online brokerage stocks is "dead money."
But is there more life in the shares of the big full-service firms and investment banks, such as Merrill, Morgan Stanley, or Goldman Sachs?
That depends on your view of the economy and the markets. Even though these firms aren't as dependent on retail trading volume, they do need some stability in the markets to restore stock and bond deal flow.
"We're expecting the markets to come back," says Diana Yates, an analyst at A.G. Edwards & Sons Inc. "It's all in how much the markets will allow some of these pipelines [of new deals] to come through. Everyone is sitting out there with their pipelines full but with nowhere to go."
The Federal Reserve, which has now moved to a loosening bias to keep the economy from tanking, could provide the catalyst for the markets, if it follows up with an interest rate cut in January, Yates says.
"It's been so slow on the underwriting, initial public offering, and debt side that anything will make some big numbers trigger positively," she says.
Indeed, in the last few weeks, shares of investment banks have started to rise, as investors bet that the capital markets will pick up, analysts say.
Shares of Goldman Sachs are up 24% in the past month, Morgan Stanley is up 15%, and Merrill Lynch is up 7%.
While fourth quarter numbers from Morgan Stanley and Goldman Sachs didn't raise hopes for a better year in 2001, they did allay some fears. Morgan Stanley earned $1.06 a share, compared with a $1.29 a share estimate, while Morgan Stanley earned $1.50 a share, versus a $1.38 estimate.
The quarterly earnings showed the ability of those companies to generate attractive returns in a difficult market, analysts say.
"That was a lousy environment," says Paul Stocking, an analyst at American Express Advisors. "If they could pull that off in the fourth quarter, and with the Fed leaning toward cutting rates, if we get a stop to the bleeding in technology, these guys may look attractive at this point."
That scenario is contingent on several market developments, and isn't guaranteed, investors say.
Nonetheless, investors in brokerage firms are accustomed to broad swings in stocks that often seem part bull, part bear.
Next year could "be pretty strong," says Yates, "depending on if we indeed get the soft landing. It could also be really ugly given everything that's out there."
Nonetheless, sounding more bull than bear, she says, "the overall economy is still quite strong, and we can afford to have a little bit of a setback here and move forward." |
