Lehman: Size Doesn't Matter

In what is shaping up to be a record year for most securities firms, Lehman Brothers (NYSE: LEH  ) today announced its fourth-quarter and 2006 full-year results to less fanfare than its investment-banking brethren had earned.

For fiscal year 2006, Lehman reported a 23% increase in net income to a record $4 billion, on a 20% increase in net revenues to $17.6 billion. Lehman reported record numbers for full-year net revenues, net income, and earnings in each business segment, and in each geographic region.

The firm held its compensation ratio even with 2005's 49.3%, producing record pre-tax margin of 33.6%. Lehman's return on equity increased from 21.6% to 22.3%. The full-year results were supported by strong fourth-quarter numbers, paced by revenue gains of 28% in its Capital Markets division, and 26% in Investment Management.

Since earnings had only slightly beat estimates, Lehman's shares slipped as of midday Thursday. Despite all the record-setting at Lehman, the firm's announcement was overshadowed by this week's blowout earnings at both Goldman Sachs (NYSE: GS  ) and Bear Stearns (NYSE: BSC  ) , in which both firms simply obliterated their estimates. It's been a stellar year for the brokerage houses altogether, and anyone owning shares of these firms has been richly rewarded. Lehman shares have outperformed the S&P 500 this year by some 5% -- but that performance is badly lagging its peer group, particularly Goldman's 50%-plus return and Bear's 40%-plus return.

But here's the real story. At half the size of its main competitors, Lehman Brothers has delivered more value to shareholders in the last five years than Goldman, Morgan Stanley (NYSE: MS  ) , or Merrill Lynch (NYSE: MER  ) have.

Consider how much the investment banking business has changed since the repeal of the Glass-Steagal Act. With staggering amounts of balance-sheet capital to win deals, the global commercial banks have now made the capital-markets business tremendously more competitive for even the largest investment banks. In a world where size matters more than ever, firms like Bear and Lehman have much less balance-sheet capital with which to lure clients. As such, they are forced to be more nimble with their capital and really "pick their spots." Yet shares of both firms have outperformed the larger players over time, a feat that's nothing short of remarkable. Although Bear's stock has bested Lehman's over the last five years, Lehman's return of nearly 1,000% over the last 10 years is unparalleled for public firms in the industry. (Goldman was not public until 1999.)

In early December, Lehman's board paid homage to CEO Richard Fuld and this extraordinary performance, awarding him an extra $188 million worth of stock to remain CEO for the next 10 years. Can you blame them? Although its competitors are stealing the headlines this week, Lehman has produced bulging bank accounts for investors over the long haul.

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Fool contributor Michael Mancini does not own any shares of the companies mentioned in this article.


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