Is This Market-Maker Ready to Make Good?
By Gene Marcial
Knight's shares have been on the skids, tumbling from a high of 81 in early 1999 to around 15 on Mar. 27, as the market has fallen and trading has declined. But this may well be the stock's low point. So argue some pros who track Knight, including Jeffery Baker of W.R. Hambrecht & Co. and Robert Sobhani of Bank of America, who both rate the stock a buy, and Gregory Smith of J.P. Morgan, who rates Knight a long-term buy.
Despite its volatility relative to the market fluctuations, "the stock's current price offers investors an attractive risk-reward entry point," says Hambrecht's Baker. He expects it to double in 12 months.
Baker notes that the company has about $6 a share in cash, so the stock at 15 (minus the $6 cash) is trading at only about 5.8 times his 2001 earnings estimate of $1.37, vs. the Standard & Poor's stock-index multiple of 26. Next year, Baker expects earnings of $1.75 on estimated revenues of $1.26 billion. Those numbers are below last year's earnings of $2.04 on revenues of $1.25 billion. In 2001, revenues are expected to be $1.1 billlion. The sharp drop in trading by individual investors has cut deep into Knight's revenues and earnings, says Baker.
But he expects its stock to outperform its peer group over the next 12 months. And with the possible big upturn in the market and the economy in 2001's second half, shares of Knight should be among the market's leaders, Baker argues.
Through its Knight Securities unit, Knight operates as a market-maker in over-the-counter stocks that are primarily traded on the Nasdaq. And the company's Trimark Securities unit is a market-maker in the over-the-counter market for stocks listed on the New York Stock Exchange and the American Stock Exchange.
Three factors drive Knight's revenues and earnings: the market's trading volume, price volatility, and business mix. And two of the three are showing positive signs for Knight, according to Baker.
Based on the strong overall market volume over the past two weeks, "we expect Knight's March trading volume to exceed our current estimates," says Baker. March should produce share volume for Knight of 7.48 billion on the Nasdaq, and 1.60 billion on the Big Board, according to Baker. That represents a 4% and a 10.7% upside, respectively, to his current estimates. He figures that these levels will become the norm in the months ahead and could well surge even more in a sharp recovery.
The market's heightened volaility in March has also helped Knight, says Baker. He notes that the average of the CBOE Volatility Index over the last 10 trading sessions has been 34.8, significantly higher than the 28.7 average over the months's first seven trading sessions. Volatility in January and February averaged 27.8 and 26.2, respectively.
High volatility usually results in a high revenue capture per share for Knight, says Baker. So the stronger volatility in March and in the months ahead should boost the company's top-line, he adds.
The business mix that represents Knight's share of institutional and retail volume, has been a wash for the company. Retail trading of stocks has slowed considerably so far this year, but that has been offset in part by the rise in institutional trading, says the analyst.
In the meantime, the betting now is focused on how much Knight will earn in the first quarter of 2001. Most analysts are forecasting 30 cents a share. Baker thinks Knight will beat that number. He expects the company to make 31 cents -- a paltry penny difference but a big deal in terms of indicating future earnings trend.
Marcial is BusinessWeek's Inside Wall Street columnist