Over the long term, brokerage companies look like solid investments.
Brokers should profit nicely from the growing number of wealthy individuals, who presumably will need brokerage services to manage their new riches.
And brokerage companies are beginning to build their nontraditional businesses, thanks to Congress' repeal of the Glass-Steagall Act. Now that brokers can offer a complete line of financial services, it may prompt some consolidation in the industry. Brokers may buy up more nonbrokerage companies, and, alternatively, banks and insurance companies may take over some of the large brokerage firms. Either trend could increase the companies' stock prices.
Merrill Lynch & Co. has been on a roll in recent months. The company's traditional investment-banking business, which underwrites securities and advises corporate clients on mergers and acquisitions, still provides the bulk of Merrill Lynch's revenue. But the company's retail brokerage business is picking up steam. Its fee-based accounts, under which customers pay an annual fee based on how much money they have in their brokerage accounts, should provide a steady source of income regardless of stock-market trading volume. Merrill Lynch is also expanding internationally and improving its banking services.
Merrill Lynch announced this year that it is developing an Internet bank. Like that of other brokerage companies, its stock price has been volatile this year. But the gains may be significant with this stock over time, and Merrill Lynch's shares appear to be reasonably priced on a forward price/earnings basis. (A forward price/earnings ratio is calculated by taking a company's current share price and dividing it by the company's expected earnings per share for the fiscal year.) Merrill Lynch's forward P/E ratio is 17, slightly below the brokerage-industry average of 18.
Goldman Sachs Group is another broker with a strong business strategy and a reasonably priced stock. Goldman Sachs is a top merger-and-acquisition adviser and the leader in bringing companies public. Goldman Sachs' investment-banking business was an important contributor to the company's second-quarter earnings, which were better than analysts had expected.
Securities trading remains Goldman Sachs' biggest business. Revenue from that unit in the second quarter was lower than in the year-earlier quarter, but it remains relatively strong when compared across the industry. Goldman Sachs has been investing in the computer system it uses to execute trades, which should lead to a higher profit margin in the future.
Goldman Sachs' share price has been unpredictable, but, given its 15 forward P/E ratio, this stock looks like a good long-term value.
Finally, take a look at PaineWebber, a company with a retail-brokerage focus. PaineWebber is targeting high-net-worth clients, so it should grow along with the number of wealthy individuals. Shares are up 33 percent for the year, but PaineWebber's forward P/E ratio remains low at 12.