Stocks For
Mom
by
TMF Ralegh
Hambrecht & Quist
Group, Inc.
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One Bush St.
San Francisco, CA 94104
Ph: 415-439-3000
http://www.hamquist.com
Dear Mom,
Just wanted to drop you a note to tell you I love you. And, oh, yeah, I wanted
to talk investments. Let's talk about great companies you can invest in,
since I don't think you should follow that time-worn, and poorly worn at
that, axe about matching your age with the percentage of bonds in your portfolio.
After all, 54 is quite young, and I think you're going to be around for a
while. Anyway, I know it's not that polite to remind a lady of her age, so
we'll just move along to the subject in question, HAMBRECHT & QUIST
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Had I written you this note a little more than a week ago, I would have told
you that I was about to make an investment in the company. Even though it
did move up pretty smartly after earnings, because analysts and investors
were expecting a pretty horrible quarter with many of the company's clients
having such a poor time in the market, H&Q did pretty well and didn't
spring any balance-sheet blowups on us. Pretty heady stuff, considering some
of the companies in its investment universe tumbled by ungodly amounts during
the quarter. Yes, there was a $4.8 million loss on investments, but that
result was a light 3.1% hit on the value of the company's portfolio of
investments and trading securities as of the beginning of the quarter. For
the quarter, Hambrecht and Quist's return on shareholders' equity was 2.8%,
or about 11% annualized. In a fair quarter, the company's return on book
value met the long-term annual return on the S&P 500. In more brisk quarters,
H&Q's return on equity has approached 12%, an amazing 48% return on an
annualized basis.
HERE'S WHAT WE'RE HOPING FOR: While earnings did decline 58% from
last year's second quarter results, principal transactions (market-making
transactions from its own inventory, which ideally grows as Hambrecht &
Quist brings more companies public) grew 17% over last year. Agency commissions,
which are plain old brokerage commissions, grew 27%, another indication of
good client base growth and growth in customer assets. Sequentially, book
value per share grew 3.2%, or 12.9% annualized, another good indication of
a solid performance in a down quarter.
Due to the cyclicality of the brokerage industry, these companies often trade
at multiples that are below what one might pay for other growth companies.
H&Q is currently priced at less than two times book value, 1.5 times
trailing revenues, and just under one times assets. To compare it to another
investment banking/brokerage company you know of, Merrill Lynch trades at
2.5 times its year-end 1996 book value, 0.76 times 1996 revenues, and 8.9%
of assets. That might make H&Q look ratty by comparison, but you have
to remember that for every $97 1/4 share of Merrill Lynch, you're getting
almost $134 per share in long-term debt, as of the end of that company's
fiscal year. Our company, on other hand, has $0.32 per share in debt. So,
H&Q is achieving the same sort of return on equity, and much better in
stronger quarters, as the industry "leader," which is laden with debt.
HERE'S WHAT TO LOOK OUT FOR: On earnings, meanwhile, H&Q is trading
at a definite premium to Merrill Lynch, at 21 times trailing earnings with
Merrill being priced at 11.6 times trailing earnings. Current consensus estimates
have H&Q growing at a 25% annual rate over the next five years, twice
the rate of Merrill Lynch. That's the growth rate I've used in my valuation
estimates for the company. If H&Q should report the $1.66 currently estimated
for 1997, the ratio of P/E to-long term growth rate (YPEG) will get back
down to that nice 0.50 area we like to see in cyclical growth companies.
Finally, let's just talk brand equity and strategic direction. The term "brand
equity" doesn't only apply to toothpaste or cars, Mom. Among the companies
in the networking, software, and PC-related industries, the company's reputation
is excellent and continues to grow stronger. Hambrecht & Quist is also
building on its investment banking, analytical strengths, and customer base
to win business in the biotech, life sciences, and pharmaceuticals as well
as consumer products industries. Companies like Texas Instruments and Adobe
have also engaged the company to run venture capital funds. With its mezzanine
financing business and venture capital expertise, the company steadily feeds
its pipeline of IPOs and corporate advisory business. In the institutional
brokerage and research world, the company is first-tier, which it has translated
into building its money management business.
Its relationships with investment banking clients also benefits its excellent
research department, grows its retail and institutional brokerage revenues,
and leads to long-term relationships in corporate finance. H&Q's brand
equity has grown steadily over the last 28 years it's been in business to
the point where it has established itself as a first-tier player in bringing
companies public. Its excellent reputation and track-record will serve the
company will as it grows other businesses such as funds management.
What we're hoping for is a ten-year hold on this company and a 15-20% per-year
shareholder return over that time. The things to look out for are defections
of key personnel, losing control over costs, and a protracted downturn in
the stock market. We know, though, Mom, that the market still tends to advance
11% per year and that new businesses will always need to seek capital. We're
also happy that H&Q doesn't carry much debt, which happens to help the
company keep flexible if a rough couple years should come along. Right now,
though, we're looking at three factors that should bring a good year to our
company: 1) The IPO pipeline is filling out, 2) Daily volume on the Nasdaq
continues to surmount 500 million shares, and 3) Merger and acquisition activity
and corporate advisory are buzzing, as downtrodden companies look for ways
to enhance their values and as leading companies seek to strengthen their
market positions.
All in all, it's not cheap -- it's fairly priced around $20 per share --
but it's still selling below where other such companies are priced. I look
at that as a fair deal, given the company's excellent growth prospects, stable
financial position, and near-franchise position in its chosen markets.
Love,
Dale |