Brokerage Stocks Are Too Rich to Buy

As retail investors pour in, valuations are spiking


As the markets have moved higher the past several years, brokerage stocks have risen along with them, but struggled to replace volumes from individual investors who fled the market. Retail-oriented investors have shunned the markets to a large degree, but we are now seeing some signs that they are returning at last.

brokerage-stocks-schw-amtdTrading volumes are picking up at firms like TD Ameritrade (AMTD) and E-Trade (ETFC) and they are reporting higher trading volumes so far in 2014.

Fred Tomcyk, the CEO of TD Ameritrade told attendees at the recent Milken Global Conference in Los Angeles that volumes from mom-and-pop investors started picking up about five months ago and have been building all year. Margin borrowing has also increased at the brokerage firms as individual investors use more borrowed money to speculate on stocks and bonds.

As retail comes back online, many think it is a sign that we may be closer to a top than a bottom in the stock market. The increased margin borrowing is a huge red flag to many traders and investors. When speculation rises, it is often an indication that markets are getting frothy. In addition, retail investors are notorious for their poor lack of timing and have a tendency to pile into stocks as the market begins to top. If that proves to be the case, many of the brokerage stocks could take quite a tumble as most of them are not cheap at current prices.

Industry leader Charles Schwab (SCHW) just reported a fantastic quarter, as trading revenues and asset management fees drove a 60% surge in profits. The firm has a record $2.3 trillion in client assets in various account types, and averaged more than 550,000 trades per day in the first quarter as investors pile back into stocks. Business is fantastic, and the stock price more than reflects that fact. The stock has risen by roughly 50% in the past year as results have improved.

And while results have been great, the stock is anything but cheap at this price.

The stock currently trades at more than 4 times tangible book value at the current price. The PE is more than 30 based on trailing earnings, which is more than 2 times the market valuation. The Shiller PE, which uses a 10-year average of earnings, is now back at levels similar to 2007 right before the stock began two-year plunge that saw the stock lose half its value. Schwab shares currently trade at more than 2 times their Graham number valuation, which uses both earnings and asset to calculate the fair value of a company.

At least one other investor seems to agree that the stock is richly priced. Chairman Charles Schwab himself has sold more than 3 million shares of the stock this year, including 1.5 million this month alone. Several other officers and directors have been selling the stock in 2014 as the price has moved higher. Investors who hold the stock might want to join them in taking some profits.

The brokerage firms that handle retail accounts have seen their stocks move much higher as individuals have returned to speculation. It is a move we have all seen before, and it has never had a particularly happy ending. I doubt this time will be any different.

As of this writing, Tim Melvin did not hold a position in any of the aforementioned securities.

Article printed from InvestorPlace Media,

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