Beware This Retail Stock Broker

by Lawrence Meyers | February 5, 2013 11:00 am

I fondly remember the good ol’ days of 1999, when every stock with a ticker symbol seemed to be going up.

As that was happening, investors also seemed to think the trend should include retail commission-driven stock brokers and names like E*Trade Financial (NASDAQ:ETFC[1]), Charles Schwab (NYSE:SCHW[2]) and TD Ameritrade (NYSE:AMTD[3]) soared.

Then, of course, they all came back to earth. The great gold rush to move online also resulted in complete commoditization of the industry. Now, every average investor can trade online for just a few bucks. Those $200 stock commissions went away and everyone had to quickly innovate to stay afloat.

The question, of course, is whether or not these stocks have since turned around. In the case of E*Trade, things don’t look so good.

The main problem is that the company made the bad move of funding mortgages. Its stock cratered from about $50 a share in early 2008 to $6 in early 2009 — and for good reason. In 2009, the company lost $1.3 billion … and it continues to experience a lot of bankruptcies in its loan portfolio. In the latest quarter, total net charge-offs came to $102 million.

Sure, the company continues to make loan modifications, but it also retains massive loan loss reserves ($481 million in the last quarter). The ghost of the housing crisis continues to haunt the company … and it isn’t going away soon.

Still, most investors think of E*Trade as a brokerage house, and perhaps there’s optimism about that division to explain why the stock is up more than 50% from its 52-week low. And on the one hand, the company did add 120,000 net new brokerage accounts in all of 2012, while retention was at  an all-time high.

The company also reported a six-year low in trading activity, though, along with a 9% decline in daily average revenue trades. Commissions, fees, and service charges pulled in $151 million, but this was down 1% from the previous quarter and down 3% year-over-year. Revenues overall were down 2% year-over-year and 5% over the prior quarter.

Maybe I’m missing something, but this doesn’t seem like its worth the optimism. Even though the company wiped out some really expensive debt via a refinance and narrowed its loss to $113 million from $157 million, that’s hardly enough to justify the price-tag.

If you’re sold on stock brokers, I like Charles Schwab better — mostly because it wasn’t exposed to very many toxic mortgages or mortgage-backed securities. The company manages almost $2 trillion in assets and is more of a traditional brokerage house with regular and institutional clients. The company had $850 million in profit over the TTM and isn’t facing the financial troubles that E*Trade is. Although a bit expensive at 19x earnings on 13% growth, it’s worth looking at on a pullback.

TD Ameritrade is also in fine shape, earning $536 million in FY12 and boasting a solid balance sheet. Like Schwab, the market is giving it an 18x multiple on 13% growth, so and could be a buy on a dip.

When it comes to E*Trade, though, don’t let a few decent numbers in a pool of worrisome ones fool you.

As of this writing, Lawrence Meyers did not own a position in any of the aforementioned securities.

  1. ETFC:
  2. SCHW:
  3. AMTD:

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