Wall Street West—Securities Veteran Finding Earnings Lessons in History

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It was 1956, the Olympics were on in Melbourne, Dwight Eisenhower was in the White House and Ed Wedbush, now president of downtown-based Wedbush Morgan Securities, was taking in a UCLA B-school professor on why the newly rich stock market was not a fleeting phenomenon.

“I remember, stocks back then began trading at 20 times earnings (per share) or more,” Wedbush, 68, said last week. “We spent a whole summer in one class looking at this, and why there was a new paradigm that would allow stocks to trade at higher price/earnings ratios from then on.” But in just a few years, in the late 1950s, stocks sank back toward their long-term P/E ratio norms between 10 and 20, Wedbush said. Of course, after another bull run in the 1960s, stocks sank down all the way into single-digit P/E ratios in the 1970s, a fact almost never mentioned today on Wall Street.

Stocks today still trade at nearly 30 times earnings, as measured by major indices, such as the S & P; 500. Wedbush is cautious.

“As much as the market has changed over the years, in many regards it remains the same,” Wedbush said. “You have momentum in the market or an industry. The upside lasts longer than it should. Then the momentum fades, then (the market or sector) loses its glamour, then it gets pummeled. But in the long-run, the fundamentals seem to stay the same.”

So Wedbush is wondering when the other shoe will drop on Wall Street investors. The major stock market indices have tumbled, but P/Es remain high by historical standards. Another crunch could be coming, he said. “I hear some of the effervescent bullishness, but I am not expecting a big rebound,” Wedbush said.

Wanting to avoid fads or periodic corrections, Wedbush likes out-of-favor industries, though he warns that quick profits are elusive even when buying near the bottom. “Sometimes an industry drops out of favor, the values are there, but it is still years before Wall Street comes around again,” he said.

Right now, Wedbush is positive about a slew of environmental or waste-remediation stocks, which have been all but toxic to investors in the 1990s, after a brief run-up in the late 1980s. Many environmental companies have become so cheap that mergers-and-acquisitions artists are performing management-led leveraged buyouts or corporate acquisitions in the sector, Wedbush said.

Out of 25 such stocks, “five or 10 have been bought out” recently, he said. In particular, he likes the Monroeville, Pa.-based IT Group Inc., involved in soil clean-ups; Costa Mesa-based Keith Cos., which engineers certain public works projects; and Peachtree City, Ga.-based Crown Andersen Inc., seller of industrial pollution controls. Wedbush also thinks certain oil-drilling stocks, down again after a run-up, are worth pursuing.

Wedbush cautions investors to study management at length before investing. Quality of earnings is ever more suspect on Wall Street, due to the near universality of tying executive compensation to stock performance.

“Reported earnings have become a travesty. You see a couple quarters with huge losses, and you say, ‘They should have been charging off those losses all along, but they didn’t, because they wanted to keep the (stock) price up and exercise their options.’ Then you see a huge writedown.” The truth comes out eventually, but only insiders knew when that will be, Wedbush said.


Sands’ Castles

Another veteran with a somewhat gloomy outlook is Fred Sands, the well-known real estate broker and developer, who is riding herd on his own $100 million mezzanine fund, Vintage Capital Group. As widely noted, banks have pulled in their horns, meaning two things for corporate borrowers: Cash to bridge through the slowdown is scarce, and financing to make acquisitions almost nonexistent.

“But if someone wants $3 million to $8 million, we don’t have to answer to a board of directors or shareholders. We can lend the money fairly quickly,” said Sands, who sold Fred Sands Realtors to NRT Inc. in December 2000 for an undisclosed amount. It was then merged into NRT’s Coldwell Banker Residential Brokerage unit. NRT is owned by Cendant Corp. and Apollo Management L.P.

While investors wallow on Wall Street, Sands is targeting 20 percent yields on his loans, plus equity kickers (though each deal has specific variations). Despite the hefty yields, Sands insists, “We are actually risk-averse. We are often making loans that would be considered senior debt (well-secured) just a couple years ago by banks.” Sands last week confirmed he has hired Stephen Krawchuk as managing director, a former DeutscheBanc Alex Brown director in Los Angeles.

Sands is also eyeing distressed real estate. “I think the worst is yet to come. We will see more pain in a year. Property values tend to lag the economy,” he said. When prices soften, Sands suggested, he will become a buyer. “One man’s crisis is another’s opportunity,” he said.


Baxter Talks

What should a manager of an independent brokerage do in a downturn? Communicate, said Harry Baxter, branch manager and family scion in Century City for Schoff & Baxter, an Iowa-based securities firm. “You gotta call your customers up, even though you are naturally reluctant to call someone whose account has gone down in value,” said Baxter.

Fortunately, as an independent brokerage without an investment banking arm, Schoff & Baxter advised customers to diversify, and not to move heavily into technology stocks, which of course suffered the most in the Wall Street corrections of the last two years. “Still, talking to customers when portfolios are up is easier than when they are down,” Baxter said. His advice when he makes a connection? “Our philosophy is to buy the best company within each industry, and never buy a stock for even 10 minutes that you wouldn’t want to own for 10 years,” he said. “Stay in the market for the long haul.”


Not at Home

Talk about bad timing. Last week, Westlake Village-based Homestore.com Inc., one of the last L.A.-area dot-coms left standing, completed the $150 million cash-and-stock acquisition of iPlace Inc., a provider of affinity marketing services. Included in the deal were 1.6 million Homestore.com shares, which once it closed promptly lost 30 percent of their value. MemberWorks Inc., the Stamford, Conn.-based seller of iPlace, saw $10.6 million of the deal’s value evaporate. Analysts said a weak housing report hurt Homestore.com, which also operates the Realtor.com Web site.

Contributing columnist Benjamin Mark Cole writes about the local investment community for the Los Angeles Business Journal. His new book is “The Pied Pipers of Wall Street: How Analysts Sell You Down the River,” published by Bloomberg Press. He can be reached at [email protected].

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