Some securities broker-dealers could post surprisingly strong earnings for the second quarter, Merrill Lynch & Co. said in a report.

Merrill raised its estimates on Morgan Stanley, Dean Witter & Co. and Lehman Brothers Holdings Inc. last month, saying record profits could be in the offing.

"The recent sluggish performance of brokerage stocks appears out of line with industry fundamentals," analysts Judah S. Kraushaar and Amy S. Butte wrote in the May 21 report.

Merrill raised its fiscal 1998 earnings projection for Morgan Stanley to $4.70 per share, from $4.35, and maintained its second-quarter estimate at $1.15. Merrill said it had the highest quarterly estimate for Morgan Stanley on Wall Street, where the consensus called for quarterly earnings of $1.11.

Merrill also raised its fiscal 1998 earnings estimate for Lehman to $5.55, from $4.90, and maintained its quarterly estimate of $1.80. The consensus among firms tracked by First Call Corp. was that Lehman would report earnings of $1.40 a share for the quarter, Merrill noted.

Though Merrill's estimates were at the high end of the scale, it was not the only firm to note strength in the sector.

In the four weeks ended May 22, average investment ratings rose for Morgan Stanley, Lehman, Legg Mason, Bear, Stearns & Co., and Merrill itself, according to First Call.

First Call, an affiliate of American Banker, averages the investment opinions on companies' stock and assigns them scores ranging from 1 for "strong buy" to 5 for "sell."

The brokerages ranged from a 1.7 score for Morgan Stanley to a 2.8 for Donaldson, Lufkin & Jenrette Inc.

Merrill noted that stock performance in the securities broker sector has been sluggish this year because of reduced takeover speculation, profit taking, and interest rate concerns.

The analysts said their action on Morgan Stanley reflected the firm's strong capital markets activity, its strong market share in the high-yield sector, and improved profitability of the firm's Discover brand credit card.

"Longer term, in light of investor worries about a market top, (Morgan Stanley's) earnings-mix shift story makes it one of our favorite stocks," they said, referring to the array of businesses put together in the 1997 merger between Morgan Stanley and Dean Witter Discover.

They set a 12-month price target of $90 on the stock, which was trading at $78.875 when Merrill issued the report and had slipped to $78.0265 by Friday.

The Merrill analysts said Lehman Brothers' earnings would be driven higher by "positive industry fundamentals" and increased revenues from higher-margin businesses such as equities, high-yield, and merger and acquisition advisory.

Beyond the short term, the Merrill analysts said they remained cautious on Lehman stock. They said Lehman is dependent on market-sensitive revenue sources, and that "a paucity of fee revenues, high cost of funds, and perception of being for sale create relative disadvantages in meeting financial targets."

Lehman, trading at $69 when Merrill issued the report, slipped to $70.6875 Friday.

Merrill also singled out A.G. Edwards & Sons as a securities broker- dealer with prospects for "robust results" when the companies report in mid-June.

A.G. Edwards' stock was trading at $42.125 when Merrill's report was issued. It was at $40.4375 Friday.

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