NEW YORK (CNN/MONEY) -
Mergers and acquisitions activity is heating up near year end, with Oracle's proposed acquisition of PeopleSoft only the latest multibillion-dollar deal.
A major merger between Sprint and Nextel is also widely viewed as imminent.
All told, the dollar value of deals announced in 2004 will likely be up more than 30 percent from last year. And the value of deals in 2003 was up 24 percent from the year before.
This upsurge is striking, even though the overall level of dealmaking is still less than half what it was in the late 1990s. M&A activity is strongly rebounding from the bear market, and the trend is extremely positive for investment banks.
Among the leaders in that group are diversified financial services companies -- such as Citigroup and JP Morgan Chase -- and purer plays such as Goldman Sachs, Merrill Lynch and Morgan Stanley.
Despite obvious short-term positives and above-average long-term projected earnings growth, the top stocks in the sector trade at low price/earnings ratios, typically less than 13 times estimated earnings for 2005 .
Even in the best of times, financial services stocks trade at lower valuations than more glamorous growth issues. But P/Es in the low teens also reflect a wide range of concerns.
The economic recovery to date has been below par, and some forecasters warn that 2005 may be another mediocre year.
Investors also worry that the enormous deficit, and the weak dollar it has engendered, may put upward pressure on inflation and interest rates. In fact, Fed watchers expect chairman Alan Greenspan to raise interest rates at Tuesday's meeting.
Banks could still benefit
Those concerns are legitimate, but consider the arguments on the other side, especially for the purer investment banking plays.
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Exposure to rising interest rates would be greatest for diversified financial services firms, such as Citigroup (Research) and JP Morgan (Research). Nonetheless, those stocks are attractive, simply because they're so cheap.
Both carry exceptionally low P/Es of less than 12 times projected 2005 results, despite yields above 3 percent and long-term projected growth rates of at least 11.5 percent.
But the purer investment banking plays -- Goldman Sachs, Merrill Lynch and Morgan Stanley -- look more timely for growth investors. These stocks have picked up noticeably since August and stand to perform quite well if the recovery revives and dealmaking continues to sizzle.
Stocks have had a fairly flat 2004, despite continuing earnings growth. And the economy is projected to grow at least a bit faster than average in 2005. So the market is due to play some catch up.
Merger activity will likely continue robustly. The industrial companies in the S&P 500 are sitting on more than half a trillion dollars in cash, an all-time record. Some of that can be used to raise dividends or repurchase shares, but there will still be plenty of money sloshing around to pay for corporate acquisitions.
In addition, the weak dollar makes it prohibitive for U.S. companies to acquire European firms. That encourages domestic mergers and also makes it a bargain for Euro corporations to buy U.S. businesses.
Finally, the Bush Administration is likely to encourage the use of tax-deferred savings accounts, either as part of Social Security reform or simply to boost domestic savings. Those assets will eventually mean additional business for brokerages and mutual fund management companies.
Of the leading investment banks, I recommended Merrill Lynch (Research), a stock on the Sivy 70 list, in early November (read that column here). Since then, the share price has gained a few dollars.
The fastest growing of the investment banks, however, looks to be Goldman Sachs (Research), which is the leading M&A advisor. Goldman's earnings are projected to increase at a compound annual rate of 13 percent over the next three years. The stock also pays a yield of nearly 1 percent.
The company is scheduled to report earnings Thursday morning, and analysts expect a gain of 22 percent for the quarter. Despite such solid prospects, Goldman looks like a bargain, trading at a P/E of less than 13.
Michael Sivy is an editor-at-large for MONEY magazine. Click here to receive Sivy on Stocks via e-mail every Monday.
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