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Stocks For Mom
by TMF Ralegh

Hambrecht & Quist Group, Inc.
One Bush St.
San Francisco, CA 94104
Ph: 415-439-3000

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 GROUP (NYSE: HQ).

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.



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