The Regional Brokers' Blues

In a market that favors big-cap stocks and Net plays, smaller brokerages are routinely overlooked.
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If you've ever felt neglected, try being a regional brokerage firm over the last few months.

While the stocks of huge brokers have mostly soared over the past few months, regional brokers have vastly underperformed the big players coming off the depths of last year's market swoon. That's not even mentioning how badly

everyone

has lagged behind online brokers, which are in their own little world.

Of course, comparing, say,

Raymond James Financial

(RJF) - Get Report

to

Morgan Stanley Dean Witter

(MWD)

or

Merrill Lynch

(MER)

is like comparing apples to pears, if not oranges.

But the pronounced gap between the regional brokers and the big New York brokerages since last year's market bottom has been astounding. And the underperformance owes a lot to the market's love affair with big-cap stocks and the Internet craze.

The laggards have their fans, but over the past few months, investors have shunned these stocks, in part, simply because they are small-caps. That mirrors the overall way the market has given small-caps the stiff-arm for years now. Many, though not all, regional brokers are trading at a discount to the big brokers, not to mention the online brokers, and they're cheap relative to the

S&P 500's

trailing price-to-earnings ratio, which was 30.5 at Monday's close.

What some of the notably hot bulge-bracket brokers have in common, besides being big, is that they've either got an online trading presence or are inching into the online arena.

While regional brokers are undervalued for the most part, don't look for these stocks to take off until investors' current love affair with big-cap and Net stocks fades a bit.

Michael Flanagan, independent brokerage analyst at

Financial Services Analytics

, says two of his favorite brokerage stocks are

PaineWebber

(PWJ)

-- which is a national broker -- and Raymond James.

PaineWebber is selling at a significant discount vs. the larger firms, Flanagan points out. PaineWebber proved in the fourth quarter it is not overly exposed to the cyclical downturns in the global markets and the investment banking business -- a big plus for the stock, he says. The company's P/E was lately 16.

PaineWebber today reported strong first-quarter earnings of $1.01 a share, walloping the

First Call

consensus estimate of 73 cents. The stock shot up 3 11/16, or 8.5%, to 47 1/4.

PaineWebber is "a strong and stable franchise that is underappreciated by the market," Flanagan says.

Raymond James is in similar circumstances, says Flanagan, citing its sound cost structure and above-average revenue and earnings growth. It, too, is trading at a significant discount compared with the larger firms. Raymond James' P/E was lately 12.3.

Flanagan says

A.G. Edwards

(AGE) - Get Report

, also a national full-service broker, is "woefully undervalued in my opinion." The firm's P/E was lately 11.7.

Another underappreciated name is

Everen Capital

(EVR) - Get Report

, says Lauren A. Smith, vice president at

Putnam Lovell de Guardiola & Thornton

. She describes Everen as a "great story," with "great management," and it's not a small firm either. But, she says, investors want big market-cap and they want Internet. Everen's market-cap recently stood at $729 million. Its P/E was lately 13.

Reflecting the big-is-king idea, and the phenomenal emergence of online trading, consider the brokerage stocks a couple of money managers own.

Mike Holland, chairman of

Holland & Co.

, says he bought Merrill stock last year at 59 and then again at 41.

Merrill has been trading at a discount to the broad market. With that discount, "the market's still saying there's some risk there," he said.

Merrill's trailing P/E ratio was lately at 26.5.

Like PaineWebber, Merrill reported strong first-quarter earnings today. The company earned $1.44 a share in the period, topping the estimate of $1.23. But Merrill's shares saw some profit-taking today after a steady recent run-up, falling 2 9/16 to 97 3/8.

Ted Bridges, vice president and money manager with

Bridges Investment Counsel

in Omaha, Neb., with $1.5 billion under management, says he likes brokerage stocks long-term, but overall they've become fully valued right now. He did say he would look to deploy capital on pullbacks.

Right now, roughly in order of size of his financial services holdings, he owns:

State Street

(STT) - Get Report

, Morgan Stanley,

American Express

(AXP) - Get Report

, Merrill Lynch,

Charles Schwab

(SCH)

,

E*Trade

(EGRP)

and

Donaldson Lufkin & Jenrette

(DLJ)

. Schwab is the largest online broker, and E*Trade and DLJ have strong positions in the market.