Investment banks and brokerages are suffering — again. In the last 30 days, the market value of the 27 companies included in this GICS sub-industry category (as defined by the Standard & Poor’s industry classification) have lost 5.7% of their market value as investors increasingly shun an industry they believe offers far more risk than it does potential for return. But those losses may just be the tip of the proverbial iceberg, as new research suggests that industry analysts will need to cut their earnings estimates for companies in this group still more to bring them into line with the ugly realities.
Certainly, 2011 has hardly been a year on which investment banks will look back fondly, regardless of what happens next. All of them — from the tiniest market-making firm to behemoths like Goldman Sachs — have seen their ability to generate profits for investors threatened by the volatility of global markets. Fewer of their clients are able to raise capital at attractive valuations, which means investment banks rake in less in the way of underwriting fees. Merger and acquisition activities have been subdued — translating into fewer advisory fees. And with volatility in major stock and bond markets hovering near historic highs for much of the year, many investors have been convinced that the safest place for them to be is on the sidelines. The result? Lower fees for making markets and trading on behalf of clients. Even Goldman Sachs, once believed to be capable of spinning straw into gold in pretty much any market environment, posted a loss for the third quarter of 2011.
Collectively, publicly-traded investment banks and brokerage companies — a category that includes regional firms like Piper Jaffray, boutique M&A advisory players such as Evercore and brokerage giant Charles Schwab — have been buffeted by these headwinds. As previously noted, their market value has been eroded, while analysts have steadily trimmed earnings estimates. Collectively, the consensus estimates – the I/B/E/S mean estimate — for earnings by these companies has been slashed by 34% in recent months. But that may just be the beginning of the pain. Our research indicates that forecasts still appear too rosy, and that more cuts may be in the offing; that, in turn, means current stock prices are resting on a perilous foundation.
SmartEstimate Changes and Predicted Surprise % Data for Investment Banks & Brokerages.
Using StarMine’s SmartEstimate model, a more accurate way to evaluate consensus earnings estimates by ascribing the greatest importance to the most timely estimates by those analysts with the best track records, earnings estimates have declined nearly 38% during the current fiscal quarter alone. StarMine has found that at times when the SmartEstimate differs from the consensus estimate by a statistically-significant amount, it serves as a leading indicator and signals the market can expect future earnings revisions that bring the consensus into line with the SmartEstimate. StarMine refers to the percentage difference between the consensus and the SmartEstimate as the Predicted Surprise Percent. When this figure is 2% or more in either direction it accurately predicts the direction of future earnings surprises about 70% of the time. Currently, that figure is negative 8% for the investment bank and brokers group. This suggests more downward revisions to come as well as the possibility of a few nasty earnings surprises early in 2012 when these firms report their results for the current quarter, ending December, 2011.
Take Jefferies, for instance — the firm around which so many rumors have swirled in the wake of controversial public criticism of its financial reporting by credit rating agency Egan-Jones. (Egan-Jones downgraded its rating on Jefferies earlier this autumn.) In the chart below, the blue line represents the StarMine SmartEstimate of 14 cents a share for the current quarter, ending December 31, while the gold line represents the broader earnings consensus figure of 21 cents a share. (One analyst, rated four stars for accuracy and timeliness by StarMine, expects Jefferies to earn only 11 cents a share.) That leaves us with a with a Predicted Surprise Percent of negative 34.1, an astonishing number that — regardless of how exposed the firm may actually be to European debt or how well-hedged those holdings may be — may well trigger some alarm on the part of the firm’s shareholders.
The chart below paints the same picture for Piper Jaffray. According to the I/B/E/S mean consensus, analysts expect the company to earn 31 cents a share for the current quarter, ending December 31. Meanwhile, the SmartEstimate moved sharply below that consensus in October, after the company reported results for its most recently-completed quarter in September, and now stands at only 24 cents.
Data like that suggests that investors who have stuck it out with the investment banking and brokerage stocks in their portfolios, hoping for a turnaround in the market environment, might be in for more rather than less bad news as 2011 draws to a close. The pain they suffer may well exceed any gains they manage to eke out.
For more insight into this data and the headwinds facing the investment banking industry, read the analysis by Reuters correspondent Joseph Giannone here.
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