Today's 3 Stock Picks: STT, RBS, FRX

Investors voted with their feet in droves Tuesday, running from the shares of State Street (STT) at a breakneck pace, cutting their value more than 50% in early trading.

The Boston-based company, the largest institutional money manager in the country, said its quarterly earnings had dropped sharply and disclosed high unrealized losses in its investments and commercial paper portfolios.

The company said its outlook for 2009 would be flat, far below its earlier double-digit growth projections.

“Obviously, the increases in the negative marks in our investment portfolio ... concern us,” Chairman and CEO Ron Logue said in a Tuesday conference call. “But we still believe that they are for the most part a result of the lack of liquidity in the market and not a result of their credit quality.”

Ladenburg Thalmann analyst Richard Bove wrote Monday that State Street’s latest Securites and Exchange Commission filing “relates all of the fashions in which this company can lose its investors money.”

The disclosures lump State Street in with other financial services stocks that continue to write down the values of their portfolios and make it difficult, if not impossible, for investors to assess the damage caused by the ongoing economic collapse. Other stocks in the sector also plunged, including Bank of New York Mellon (BK), Bank of America (BAC), PNC Financial Services Group (PNC) and Wells Fargo (WFC).

Bove said State Street’s latest blow to the sector is a question of confidence.

“Investors do not believe that the company has properly marked-to-market its securities portfolio,” he wrote, adding that it implies State Street needs to reassess its capital levels, a move that could force them to raise new capital and dilute share values. “The company has to this point argued that this is not likely to happen and that new capital is not needed. The new risk factor raises the issue as to whether the company has changed its mind on this point.”

The Bottom Line: Hold
Investors should have known that just because State Street was slow to issue warnings didn’t mean it avoided the problems of its industry peers. Anyone holding this stock can’t sell into this kind of drop, but neither should they be surprised at the size of this move.

American investors did their best to sever ties with the United Kingdom’s battered banking industry on Inauguration Day, driving depositary shares of the Royal Bank of Scotland Group (RBS) lower after it announced probably the largest loss in that country’s history.

News Monday that RBS could lose $41.1 billion in 2008 prompted a massive selloff in that stock and other U.K. financial firms amid growing fears the bank could be entirely nationalized. The government now owns about 70% of RBS.

“I guess the simple starting point on outlook is that the world remains uncertain,” group CEO Stephen Hester said in a Monday conference call. “I think we and all banks can be certain that there will be more significant losses as the recession plays through.”

Alexander Potter, an analyst at Collins Stewart in London, said the United Kingdom’s banking crisis has continued to grow since last year’s nationalization of mortgage lender Northern Rock. He said RBS has taken a step closer to full nationalization, and that has hit other U.K. banks, including Lloyd’s Banking Group (LYB) and Barclays (BCS).

“It’s crystallized fears that further capital raises will lead to full nationalization,” Potter says. “There’s unlikely to be any compensation for equity holders.”

Prime Minister Gordon Brown, a former Chancellor of the Exchequer, on Monday announced another rescue plan that would insure banks against further losses in exchange for their boosting lending levels. Three months ago, the U.K. put forth a $588 billion bailout package that failed to stem the financial sector’s decline.

While the United Kingdom’s financial regulatory and policy bodies are more closely aligned than the Federal Reserve and the Department of the Treasury in the United States, Potter says closer coordination hasn’t yet led to a successful policy response nor better disclosures that could allay investor fears.

“We’ve still got no clarity on what they’re proposing,” Potter says. “Right now, we’ve got a round, general form of what the government is planning, but still nothing definitive.”

The Bottom Line: Sell
Anyone who stayed with U.K. banking stocks couldn’t fail to be aware of the precarious risks they face, and the fate of Northern Rock shareholders should have served as a clear signal for the fate of troubled institutions.

Investors gave a slight boost to Forest Laboratories (FRX) Tuesday, continuing a spike in the pharmaceutical company’s shares after the Food and Drug Administration last week approved a drug to treat fibromyalgia, a chronic muscle and joint disorder.

Forest also raised its fiscal outlook Tuesday, saying it would reduce research and development spending during the recession. The company said it now expected earnings of $3.35 to $3.45 a share. Wall Street analysts earlier forecast an average of $3.22 a share.

In a Tuesday conference call, President and CEO Larry Olanoff said the company would release Savella, the new drug, to the market soon and it would be available in pharmacies by March. Forest developed the drug with Cypress Bioscience (CYPB).

The new drug is a boon to Forest, which derives about 60% of its revenue from sales of the antidepressant Lexapro, which the New York-based company sells on behalf of H. Lundbeck, a Danish pharmaceutical company. Forest has seen its market share for antidepressants decline over the last year.

Thomas Weisel Partners analyst Donald Ellis wrote last week that the FDA approval was a significant step to replace revenues from Lexapro and Namenda, a drug used to treat Alzheimer’s disease and dementia. He said a delay from a scheduled ruling in October could account for the boost in share prices.

“Given this delay and that first-pass approvals from the FDA have become increasingly rare, many investors may not have been expecting an outright approval,” he wrote in a Thursday report.

The Bottom Line: Sell
This may well be a near-term peak for Forest, and taking profits could be a smart move.