A rising market should lift asset managers' earnings this quarter. But analysts warn that some stocks in the group may already have crested.

According to fund tracker Lipper, the average large-cap growth fund rose 3.5% from April through June, compared to 1.4% for the

S&P 500

index. Mid-cap growth funds added 3.1% in the quarter, while small-cap growth funds led all categories with a gain of 4.2%. On the value side, small-cap funds also bested the big guys, returning 3.1%. That compares with gains at mid- and large-cap value funds of 2.6% and 1.3%, respectively.

The positive ripple in stocks has created a near tidal wave in asset management stocks. The group is up over 8% since the start of the second quarter, as investors looked for a way to leverage the market's rally. Plus, there's hope of more take-outs in the wake of the

Legg Mason

(LM) - Get Report

-

Citigroup

(C) - Get Report

asset management-brokerage business swap.

Asset management companies, and the mutual funds they manage, tend to rise and fall with the market. When stocks go up, their earnings generally follow.

Some analysts tracking the group say the rapid run-up in share prices lately increases the likelihood of difficulties going forward, especially if markets cool and fund flows weaken.

"The third quarter could be challenging from a mutual fund flow perspective," says Rob Lee, analyst at Keefe Bruyette & Woods. "We think investors in asset management stocks need to be particularly discerning, and focus on companies that should be able to demonstrate continued robust net asset flows and in our view trade at more reasonable valuations."

Assessing the Asset Managers

John Hall, equity research analyst at Prudential, separates asset managers into the "haves" and "have nots" in his most recent note. Hall lists

Franklin Resources

(BEN) - Get Report

and

T. Rowe Price

(TROW) - Get Report

atop his list of haves, due to their prowess in bringing in new money.

Last week, Franklin said assets under management rose to $425.4 billion in June, compared with $417.3 billion in May and $350.8 billion in the same month a year earlier. Much of that flow was directed into international equity funds. Their performance has cooled recently, yet they still remain popular as investors' growth hopes move to Asia and India.

Hall recently boosted his third-quarter earnings estimate to 95 cents, in line with the consensus estimate and up from 76 cents last year. Franklin is scheduled to report on July 28.

T. Rowe will report quarterly earnings on July 27. Analysts expect T. Rowe to earn 74 cents a share, up from 60 cents last year, on revenue of $366 million.

Both Franklin and T. Rowe are currently trading at over 19 times 2006 earnings estimates, or 20% higher than the group average of 16. And while it looks like shares of Franklin are getting pricey, most analysts say the company is worth the premium.

"We believe Franklin should trade at a 15% premium to peer averages, given its size, scope, global footprint and solid investment record," Merrill Lynch analyst Guy Moszkowski wrote in a recent note.

Moszkowski also likes

Alliance Capital

(AC) - Get Report

, which trades beneath the market multiple at 14.4 times earnings estimates. Alliance reports results on July 26. Analysts expect the company to earn 67 cents a share, up from 53 cents last year.

Alliance surprised investors on Tuesday, however, when it reported a 0.4% sequential decline in June assets under management to $516 billion, from $518 billion in May. At this time last year, the company's assets were $482 billion.

Alliance is also the top pick of Rob Lee from KBW.

Merger Mysteries

In contrast with Franklin and Alliance, beleaguered

Janus

(JNS)

can't catch a break in the analyst community.

Hall ranks the company, which reports earnings on July 28, among his have nots and Matt Snowling, analyst at Friedman Billings Ramsey, rates Janus a flat-out sell due to its relatively high forward multiple of 26 times earnings.

"Janus currently sells at a premium to the group because people see it as a good play for growth stocks," says Snowling. "But it is still losing assets. You pay a discount for a turnaround story, not a premium."

Analysts expect Janus to earn 11 cents a share, down from 17 cents last year, on $237 million in revenue.

One reason for the strength in Janus' shares may be speculation that the company is a potential take-out candidate. Janus shares rose in response to a Canadian fund manager's effort to acquire

Amvescap

( AVZ), the owner of the AIM and Invesco brands, earlier this month.

In fact, the industry has been rife with M&A talk since Citigroup sold its asset management business to Legg Mason for $3.7 billion, or roughly 0.8% of the $437 billion in assets it acquired. That deal, which vaulted Legg into the top five asset managers with over $830 billion under its roof, was applauded by the research community as being complementary.

In terms of valuation, Legg, which trades at a premium of 20 times forward earnings, paid a bargain 15 times trailing earnings for Citigroup's fund division. But, then again, Citigroup's decision to sell was more of a strategic one, partly to restructure the company to avoid future conflicts of interest.

FBR's Snowling says that any company in the market for a mutual fund shop would be better off avoiding high-priced stocks like Janus. A better plan, says Snowling, would be to wait to see if other investment banks, like

Morgan Stanley

( MWD) and

Merrill Lynch

( MER), follow Citigroup's lead and shed their asset management divisions.

"M&A is picking up for asset managers, but it will be a buyer's market for things coming down the road," says Snowling. "Divestitures from Morgan and Merrill may be sold at discounts, while public asset managers are trading at premiums. That shows there is a disconnect.

"If a lot of sellers come to the market, you could see prices coming down," adds Snowling, who believes that Franklin could be the next big acquirer. It has more than $3 billion in cash, much of it in foreign monies waiting to be repatriated, Snowling says.

To view Gregg Greenberg's video take on the outlook for asset managers, click here.