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Brokerage Profit Forecasts Show Importance of Diversification

MARKET SAVVY | SAVVY CONFIDENTIAL

October 12, 1999|Bloomberg News, Reuters

Donaldson, Lufkin & Jenrette Inc., the eighth-biggest U.S. securities firm, is expected to demonstrate this morning why Wall Street is working so hard to diversify its sources of profit.

The company, whose business is concentrated in high-yield bonds, was forecast to report that it earned 76 cents a share in its third quarter ended Sept. 30, according to the average estimate of seven analysts. Though that marks a fivefold increase over the shaky year-ago quarter, it's down 11% from the 85 cents forecast as recently as Sept. 20, thanks to a slump in underwriting and trading of lower-rated debt in the last two months.

"DLJ is a leader in the high-yield market and has a lot of eggs in that basket," said Henry McVey, an analyst at Morgan Stanley Dean Witter & Co.

By contrast, the third-quarter estimate for more diversified Merrill Lynch & Co., the nation's No. 1 retail broker and underwriter, has remained steady at $1.29 a share since Sept. 20, according to earnings-tracker First Call Corp. And PaineWebber Group Inc., with a larger retail business than DLJ, was expected to report it earned 83 cents a share, an estimate also little changed recently.

Compared with a year ago, many of the major brokerage firms are expected to post stellar third-quarter earnings gains. Their results a year ago were depressed by the global market calamity that ensued after Russia's debt default in August 1998.

As the accompanying chart shows, Merrill's year-over-year profit growth could be among the best in blue-chip Standard & Poor's 500 index.

But investors are looking past the current period to 2000 and beyond. Concerns about rising competition--and about the U.S. stock bull market's longevity--have weighed heavily on brokerage stocks this year.

To convince investors they can become less vulnerable to market vagaries such as the Russian troubles, U.S. securities firms are building asset management, retail brokerage and advisory businesses that generate steady fees and help stabilize earnings.

Lehman Bros. Holdings Inc. shares jumped 16% since Sept. 23 after the company, long known as a bond house, reported its best-ever quarter in investment banking and equities.

Likewise, Morgan Stanley Dean Witter & Co. sailed through rough markets last year relatively unscathed, helped in part by its ownership of the Discover card, the No. 4 credit card brand in the U.S. Morgan's shares are down 19% from their 52-week high, but they've held up better than many rivals, including Merrill, whose shares are down 33% from their peak.

"Diversification is a huge benefit in our minds," said Timothy Ghriskey, portfolio manager at Dreyfus Corp., which oversees $100 billion, including Morgan shares. "It really lets different lines of business carry the ball at different times."

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Meanwhile, in what some analysts see as the latest trouble sign for the online brokerage industry, Knight/Trimark Group Inc., Nasdaq's biggest market maker, said Monday that its third-quarter profit will fall well below estimates because of slackening trading volume, less volatility in share prices and pricing improvements for customers. The warning sent Knight/Trimark's stock tumbling $3.56, or 12%, to close at $26.38 on Nasdaq. The shares are down more than two-thirds from a May high of $81.63.

Knight/Trimark, which processes many of the stock trades that individual investors make on the Internet, said it will report profit of 17 to 19 cents a share, versus analysts' consensus of 30 cents. The company made 13 cents a share in the year-ago quarter. The firm, based in Jersey City, N.J., will post results Wednesday. It said it expects to report revenue of $138 million, up nearly 50% from a year ago.

The announcement follows a projected 10% decrease in online trading volume for the third quarter, marking the first sequential quarterly decline since Net trading started to catch on in 1996. Rising interest rates and uncertainty over the market's direction have caused the decline, said analyst Amar Mehta of CIBC World Markets.

Knight/Trimark is a market maker, or share dealer, in more than 7,000 stocks. It makes money on the difference between the prices it pays for shares and the prices it sells them, also called the spread. A decline in share volumes hits the firm's bottom line.

Merrill downgraded its rating Monday on Knight/Trimark to "near-term neutral" from "accumulate."

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