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The Best of the Boutiques
Four off-Wall Street research firms offer their picks.
February 20, 2003: 9:36 AM EST
By Erica Garcia, Money Magazine

NEW YORK (CNN/Money) - If you read only the headlines, you might think that all financial analysts work for Merrill Lynch or Salomon Smith Barney. But the world of stock research extends far beyond the big Wall Street brokerage houses.

Indeed, when mutual fund managers and other investment pros want a clear-eyed view on stocks, they often turn to much smaller firms, some based far from New York City.

Top Boutique Picks
Seven stocks leading research firms like
Company Ticker2003 P/EGrowth rate
BiogenBGEN236%
Esco TechnologiesESE1625
John HancockJHF97
PetsMartPETM21134
TorchmarkTMK99
VerizonVZ14-10
XL CapitalXL958
Growth rate based on current year projections versus prior year. Source:Baseline

What makes these firms noteworthy is their narrow focus -- they tend to cover only one segment of the market -- and their independence: Since they usually don't have an investment banking arm, their analysts are free to issue negative opinions without worrying about offending potential clients.

To find the best of the boutiques, we called more than a dozen leading money managers and asked them to name their favorites.

Below, we profile four firms that were cited again and again for their prescient calls and thoughtful analysis, and we detail their current top stock picks.

Avalon Research Group

Avalon's analysts routinely attend medical conferences on clinical trials and survey clinicians about drugs pending Food and Drug Administration approval. They're always on the lookout for omissions or dubious data.

That process led the firm to its biggest coup, says David Hines, Avalon's president and research director. After examining ImClone's (IMCL: Research, Estimates) presentation from Phase II trial results on its experimental cancer drug Erbitux, Avalon analysts were convinced that the company had not met the FDA's requirements. They urged clients to sell the stock in the spring of 2001, well before ImClone's problems became widely known.

Looking ahead, Avalon disagrees with many Wall Street analysts who believe that the FDA has become more lenient in its approval process. "The FDA will be as rigid and slow-paced as ever," asserts Hines.

Picks: Avalon likes Biogen (BGEN: Research, Estimates), betting that Biogen's new psoriasis treatment, Amevive, which received FDA approval in late January, will be a big hit. The research outfit surveyed dermatologists and found enthusiastic reception for the skin-disorder treatment. Biogen trades at $37, 22 times the $1.68 a share Avalon predicts it will earn in 2003.

Among the companies that Avalon has concerns about is Forest Laboratories (FRX: Research, Estimates). Avalon thinks sales of its antidepressant Lexapro will fail to hit lofty expectations. Its analysts believe Forest Labs will see sluggish demand in 2004 for Celexa, another of its antidepression medications, and fears that the drugmaker's frothy price-to-earnings ratio of 26 versus the average of 15 for its peers makes it vulnerable to any bad news.

Fox-Pitt Kelton

Here's an example of this New York City firm's clout. Last year it issued a report warning that asbestos liability claims would be a bigger problem for the property/casualty insurance industry than most on Wall Street believed.

After the report came out, many of these companies responded by raising their reserves for such claims, even though that meant that their profits -- and their stocks -- suffered as a result.

Picks: Fox-Pitt now says the outlook for the property/casualty industry is good, as higher premiums replenish coffers. In particular, the firm likes XL Capital (XL: Research, Estimates). The Bermuda-based insurer has no exposure to asbestos-related claims. Moreover, Fox-Pitt believes XL's move to broaden its offerings with such products as weather insurance for municipalities will boost its growth rate.

Better yet, the company's shares trade for 10 times 2003 estimated profit, below the property/casualty industry average of 12.

As for life insurance companies, Fox-Pitt contends that the stock market slump will hurt those that relied on peddling annuities. "With the volatile stock market, annuities are less likely to be attractive and market sentiment will shift back to traditional insurance products," predicts Alan Zimmermann, Fox-Pitt's director of research.

Those that stand to benefit include Torchmark (TMK: Research, Estimates) and John Hancock (JHF: Research, Estimates). Each company boasts a formidable sales force as well as a strong market presence. Both stocks trade at nine times 2003 estimated profits, which is well below the life insurance industry's average P/E of 13.

Sidoti & Co.

Big Wall Street houses tend to focus their research efforts on large-cap companies -- in part because most of their investment banking clients are large-caps -- while overlooking the small-fries. That's one reason 20-year veteran small-cap analyst Peter Sidoti launched Sidoti & Co. in 1999.

Today the firm fields an army of 41 analysts who track and report on some 265 companies, most with market capitalizations of less than $1.5 billion.

Picks: Sidoti believes now is a great time to invest in small-caps. He points out that historically, smaller companies outrun their bigger brethren coming out of a market downturn. Among the firm's favorites is Esco Technologies (ESE: Research, Estimates).

The company sells specialized filters for consumer products--such as Brita water filters--and for industrial uses in the health-care and airline industries. Sidoti predicts profit will grow by at least 20 percent annually over the next couple of years. Esco currently trades at 17 times estimated 2003 profits.

On the larger side of the small-cap universe, Sidoti is pounding the table for PetsMart (PETM: Research, Estimates), the nation's largest pet-goods retailer. Sidoti is an ardent fan of the company, which the researcher started following last year; it carries a market value of $2 billion.

PetsMart is emphasizing higher-margin services, such as training and grooming, and plans to open 120 new stores during the next two years. Sidoti says these moves will fuel 20% earnings growth in that period. At $15.54, the stock trades for 18 times this year's estimated earnings.

Precursor Group

Founded shortly after the Internet bubble burst in the spring of 2000, the Precursor Group has quickly carved out a name for itself in the telecom industry. This Washington, D.C.-based outfit is full of inside-the-Beltway players. CEO Scott Cleland is an ex-State Department aide, and President William Whyman once was a director of the National Economic Council.

One of Precursor's shining moments: a summer 2001 report labeling WorldCom "Dead Model Walking," published long before the long-distance telephone company filed for Chapter 11 bankruptcy.

Picks and pans: Last fall the firm became very upbeat on the telecom industry, sensing a policy shift at the Federal Communications Commission that would be a boon for the Baby Bells. Cleland notes that the four Bells--BellSouth, SBC, Qwest, Verizon -- represent two-thirds of the industry's capital spending and market capitalization.

An impending FCC ruling is expected to free the Bells from having to lease their local telephone networks to competitors at an operating loss. Precursor argues that this will help the Bells to improve profitability. Its favorite of the four: Verizon (VZ: Research, Estimates). Cleland calls the largest of the Baby Bells "the most evolved" when it comes to adapting to the changing competitive landscape.

On the flip side, if this much-talked-about decision goes through, it will hurt the long-distance companies. As it is, Precursor is sour on AT&T and WorldCom and says they'll continue to struggle as long-distance rates keep falling. Cleland asserts that the only way for them to survive is to be acquired by a Baby Bell.  Top of page




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Most stock quote data provided by BATS. Market indices are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer. Morningstar: © 2018 Morningstar, Inc. All Rights Reserved. Factset: FactSet Research Systems Inc. 2018. All rights reserved. Chicago Mercantile Association: Certain market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. Dow Jones: The Dow Jones branded indices are proprietary to and are calculated, distributed and marketed by DJI Opco, a subsidiary of S&P Dow Jones Indices LLC and have been licensed for use to S&P Opco, LLC and CNN. Standard & Poor's and S&P are registered trademarks of Standard & Poor's Financial Services LLC and Dow Jones is a registered trademark of Dow Jones Trademark Holdings LLC. All content of the Dow Jones branded indices © S&P Dow Jones Indices LLC 2018 and/or its affiliates.