Stock Screen: The Case for the Online Brokerage

By Covering Business     March 28, 2013

By Khadeeja Safdar
Columbia Journalism School C’13

The stock market is on a tear. Retail investors who shied away during the recession are now returning to stocks in droves. One of the most obvious beneficiaries: online brokerage firms. If the rally continues, stocks such as TD Ameritrade, Charles Schwab, Scottrade and E*Trade, which primarily make money by taking a cut from each trade placed on their platforms, should pick up steam.

The Dow Jones Industrial Average recently hit its highest point since October 2007, and many market watchers project more gains this year. Investors have been pouring money into stock funds recently. In January, equity funds posted their largest inflows for any four-week period since 1996, according to Lipper.

Shares of brokerage firms have benefitted. The iShares Dow Jones US Broker-Dealers Index began outperforming the S&P 500 in December.

If market activity continues to rise, higher trading volumes should drive more growth among online brokerage firms. Here are three U.S. retail brokers whose shares should post near-term gains.

Charles Schwab (SCHW)

Shares of the brokerage Charles Schwab have been outperforming the S&P 500 since December. The stock hit a record high just after the Dow’s recent milestone.

With a market cap of $22.3 billion, Charles Schwab has solid fundamentals. The company increased its fourth-quarter earnings per share by about 15 percent over the year-ago period. Revenue was up 8 percent over the same period. Schwab’s operating cash flow jumped by nearly 100 percent in a year, significantly above the industry average, a net loss of about 90 percent.

The caveat for Schwab is that growth expectations may have already been factored into its stock price. The company has a trailing 12-month price-to-earnings ratio of 25.21, above the S&P 500’s price to earnings ratio of 17.87.

TD Ameritrade (AMTD)

A cheaper option for a brokerage stock is TD Ameritrade. The company has a price-to-earnings ratio of 19.62, slightly above the average for the S&P 500, but below its industry median.

Ameritrade has recently done better than expected on a quarterly basis. The brokerage earned 27 cents a share in the first quarter, exceeding analyst estimates of 24 cents.

Ameritrade reported a net gain last year but failed to post any revenue growth. However, that could soon change, considering retail investors’ renewed interest in the stock market,

E*Trade Financial (ETFC)

A riskier bet for short-term investors is the online retail brokerage E*Trade. The stock has underperformed its competitors and has a beta of 2.3, suggesting a lot of volatility.

The company also made a major management change in January, naming Paul Idzick, the former chief operating officer of Barclays, as its new chief executive. Since then, E*Trade has undergone significant cost-cutting and debt management measures to restore a bottom line depressed by the recession.

E*Trade’s stock price surged 32 percent this year – more than three times the gain of the S&P 500 – but shares recently plummeted after its largest stakeholder Citadel LLC, a Chicago-based hedge fund, announced it would sell its 9.6 percent stake. Citadel made investments totaling more than $4 billion in 2007 and 2009 to help E*Trade survive the bad bets it made on mortgages during the housing crisis.

Citadel’s recent sale might signal the hedge fund has given up on E*Trade. On the other hand, it could mean the online brokerage firm has become self-sufficient. If that’s the case, now may be a good time to buy the stock on the cheap. The company’s second-quarter earnings release, scheduled for April 15, will be crucial in determining its prospects.

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