Brokerage King and Broadcom: Timing Is Everything

Stock Exchange gives readers a chance to listen in as staff writers James Peltz and Michael Hiltzik debate the merits of individual stocks.

Merrill Lynch (MER)

Jim: We start with the famed investment house started by that carousing chap “Good Time Charlie” Merrill, who wanted to “bring Wall Street to Main Street” and created what remains the biggest brokerage firm in the country.

Mike: Today the firm is run by a veteran Wall Streeter named David Komansky.....

Jim: . . . a bear of a man who fills a room when he enters, and I mean that figuratively too, because I’ve had the pleasure of meeting him.

Mike: He is the least CEO-looking CEO I’ve ever seen. But he’s really on his game these days, Jim. Merrill Lynch is extremely prosperous right now and also has tremendous potential.

Jim: The firm, maybe, but I’m not sure about the stock. First, though, let’s just note that Merrill Lynch is not only the largest brokerage, but one of the world’s biggest investment bankers. It underwrites stocks and bonds and advises on corporate takeovers--all of which bring in enormous fees.

Mike: It’s also one of the top money managers globally.

Jim: Correct. But there’s a problem here. Despite Komansky’s masterful job at growing the firm, it seems Merrill Lynch’s stock is beholden to the Dow Jones industrial average. This stock hit $109 in July, then plummeted right along with the market until it bottomed in the mid-30s in early October. And now that the market has roared back, Merrill Lynch has rebounded to the mid-60s.

Mike: Right, but it’s got a price-to-earnings multiple now of about 18, which seems very attractive for such a leader in its field.

Jim: On the surface, yes. Trouble is, the E in that P/E is now so unpredictable. As the market has bobbed up and down, the analysts have raised and lowered their earnings estimates for the firm. So exactly what level of earnings is Merrill’s price really buying? And now I’m worried that the stock market is top-heavy and could be poised for another pullback--does that mean Merrill is ready to tank again?

Mike: Is this your way of saying you’d avoid the stock?

Jim: I would, for now.

Mike: I agree with your arguments--and disagree with your conclusion. Merrill Lynch absolutely is a proxy for the market. That’s inevitable when you have a brokerage that’s so big and so involved in every corner of financial services.

Jim: It’s synonymous with Wall Street.

Mike: Actually, you might as well call it a bank. You can get an account at Merrill Lynch that does everything for you that your bank does. Whether it does it better or not, who knows? But it’s certainly a full-service financial supermarket.

Jim: You were saying?

Mike: You’d agree that our general assumption here is that, over time, the stock market is going to be in the investor’s favor?

Jim: Agreed.

Mike: Then why wouldn’t you buy Merrill Lynch as a proxy for the market?

Jim: Your argument holds water if we’re looking at Merrill Lynch as a long-term investment, one held for years. But near-term, I’m not wild about a stock that gets two-thirds of its value ripped away in a couple of months because the Dow drops 20%, even though the firm itself is doing quite nicely.

Mike: Merrill Lynch would have been an even greater buying opportunity at that point.

Jim: You’re just validating my point. I’d wait to buy this stock until the market goes south again. Now, we can’t predict when that will happen, but one can argue that the market is due to let off some steam after its big comeback this fall.

Mike: What we’re really arguing about is a question of timing, because we agree Merrill Lynch is a good company and that even at this level the stock is not overpriced by traditional measures.

Jim: Right.

Mike: We also should remember that financial services are fungible. The brokerage services from Merrill Lynch or Charles Schwab or PaineWebber are pretty much the same. So Merrill Lynch’s size and breadth--its enormous range of services to companies and consumers alike--is going to be an advantage.

Jim: Good point. When you look at all the changes in financial services over the last two decades--discount brokerage, online brokerage, the globalization of underwriting, the mergers of financial firms--Merrill Lynch gets lots of credit for staying atop the heap.

Mike: And, not to be too cynical, but think of the takeover premium potential in this stock.

Jim: That’s true. Merrill reportedly talked to Chase Manhattan, the nation’s biggest bank, about a merger earlier this year. And in light of Citicorp and Travelers actually joining forces to form Citigroup, it wouldn’t surprise me if Merrill Lynch eventually does a deal.

Mike: Though it’s probably one of the few firms big enough to survive by itself.

Jim: If Merrill Lynch strikes a deal instead, though, we have to revisit our discussion.

Mike: We’ll have to start from scratch.

*

Jim: Don’t Buy

Mike: Buy

Broadcom (BRCM)

Jim: This is an Irvine-based maker of specialized electronics chips and .... . .

Mike: Before you go any further, the most pertinent statement one can make about this company from the outset is: What a difference a day makes.

Jim: No kidding! Broadcom’s gyrations lately have put Amazon.com to shame.

Mike: I know that when we first talked about doing Broadcom, you really had a gleam in your eye.

Jim: I did.

Mike: Unfortunately, so did a lot of other investors.

Jim: Right. Mike, if there was ever an occasion when we should have killed a stock from this column and called our brokers instead, this was it.

Mike: Too late. A couple of days ago, Broadcom sold for $90 a share. Some 48 hours later, $120--and without any major news from the company. Fair to say this one isn’t easy to call.

Jim: Not for me. Upfront I’ll say this is a very good company with a bright future, but I’d pass on the stock right now.

Mike: We’re getting ahead of ourselves. Let’s talk about what Broadcom does. Simply put, it makes chips designed to bring the Internet, television and cable broadcasts to your TV set.

Jim: Seamlessly.

Mike: That sounds like it should be simple because, after all, your computer has a monitor and your TV has a video screen. But in fact, these are two entirely different technologies that are not easy to bring together. Enter Broadcom with its fancy chips, which essentially convert computer-standard signals to video signals so they can be displayed on your living-room TV.

Jim: Its chips are placed inside of the cable set-top box on that TV, which is why some of their big customers are set-top box makers like Scientific-Atlanta and General Instrument.

Mike: Now, if you believe as I do that the future of computing power is not to make faster and better home computers, but to make smarter and better TV sets, radios, toasters and microwave ovens, then this is a business with a great future. Among other things, it’s going to help bring the Internet to the 40% to 50% of Americans who don’t have computers.

Jim: And apparently don’t want them. It’s been said many times that for a good number of people, it’s still too much bother to use a PC compared with watching TV.

Mike: And as soon as we get Bill Gates out of the way, it’ll probably happen pretty quickly.

Jim: For now, though, Broadcom’s chips are a big step in that direction. There are other reasons to like this company. Broadcom is only 7 years old, yet it’s already nicely profitable. It earned $24 million on sales of $133 million in the first nine months of this year--a tidy 18% margin after taxes. It has no long-term debt.

Mike: And it’s the leader in its field.

Jim: Broadcom went public in April at $24 a share, then did a secondary sale in October at $69--so CEO Henry Nicholas and other insiders could cash out big-time.

Mike: Which brings us to today, and, as with Merrill Lynch, I think the crucial issue here is timing.

Jim: Right. With the stock north of $100 a share, it’s trading for nearly 150 times those wonderful earnings I just noted. If it fell back to $90 or, even better, $85, I’d buy it.

Mike: Now, if you look ahead, obviously Broadcom isn’t going to have this market to itself, because the market is going to be too lucrative. And people can see that Broadcom already has earnings.

Jim: Unfortunately, the price relative to those earnings is just too dear right now.

Mike: As we’ve said before, when you buy a stock with a P/E that’s somewhere between 160 and infinity, you stop talking about investing and move into the area of ... . . I don’t know, theology?

Jim: Some call it mere speculation.

Mike: Whatever. Point is, you believe that everyone after you will value the stock at even higher prices, because the company’s potential is truly astronomical, because you think it will be able to exploit a functional monopoly for a long time. But when it comes to Broadcom, all of these issues are much too speculative to recommend the stock right now, much as I think this is a great company with a great product.

Jim: And a great future. What could be more critical than merging two of the greatest technologies of our time, the TV and the computer? But I’d wait until the stock falls back.

Mike: Agreed. That would take some of the speculative froth out of Broadcom, although nobody will mistake it for a cheap stock.

*

Jim: Don’t Buy

Mike: Don’t Buy

Do you have a stock you would like to see discussed in this column? Michael Hiltzik can be reached at michael.hiltzik@latimes.com; James Peltz can be reached at james.peltz@latimes.com. Or write to either at Business Section, Times Mirror Square, Los Angeles, CA 90053.