When it comes to online brokers, the top six firms hold nearly $4 trillion in client accounts. Of those that are publicly traded, there is one that has severely underperformed the others due to its poor banking practices. I’m talking about E TRADE Financial Corporation (NASDAQ:ETFC), which was named Kiplinger’s best online brokerage of 2012. With the constant praise that the brokerage division receives, is this one worth a look at the current depressed levels, or is it a lost cause at this point?
With the mortgage crisis getting close to being in the rear-view mirror, why is E TRADE Financial Corporation (NASDAQ:ETFC) still trading for such a low price? After reaching a (split-adjusted) high of $277.60 in 2006, the stock started falling when the mortgage bubble burst, settling at a low of $5.90. It has since rebounded to the $11-range, a ways off from its glory days. The company has been trying to turn around, but has managed to post positive earnings for only one year since 2006.
Following the mortgage crisis, E TRADE Financial Corporation (NASDAQ:ETFC) received a cash infusion of $2.5 billion from Citadel Investment Group, which got E-Trade’s $3 billion asset-backed securities portfolio off of their books, and got the company some much-needed liquidity.
Since the crisis, E-Trade has focused its resources on becoming the best online brokerage, and has succeeded for the most part because of its feature-packed software and highly successful ad campaigns (the E-Trade baby is one of the most recognizable advertisement characters in the entire marketplace).
As I have said in several other articles, uncertainty can create great opportunities. Right now the market is uncertain of E TRADE Financial Corporation (NASDAQ:ETFC)’s ability to turn itself around and become consistently profitable. As mentioned, the company lost money last year, but is expected to earn 54 cents per share this year, which is expected to grow to 66 cents and 77 cents in 2014 and 2015, respectively. So, E-Trade is priced at 21 times forward earnings with a 3-year average growth rate of 19.5%.
Now, I am not at all advocating an investment in E-Trade of money that you cannot afford to lose. For a retirement portfolio, for example, the best move may be one of E-Trade’s competitors. I am bullish on this sector in general, because as the economy continues to recover, more money will be invested, more stock will be traded, and more commissions will be earned.
TD Ameritrade Holding Corp. (NYSE:AMTD) is a much more stable, solid company, and trades for 19.8 times TTM earnings. The consensus calls for forward growth of about 8% which sounds a bit pricey. The company’s earnings have actually been pretty flat in recent years, and I would need for that to change drastically before I consider paying such a premium for the stock.
Schwab looks even worse, trading for 25.6 times earnings with just 7% forward growth projected. While Schwab has arguably the most loyal and affluent client base of any of the online brokers, I simply don’t see the reason for such an inflated valuation.
One potential silver lining for these companies, albeit several years in the future, is the potential for serious earnings growth when interest rates finally begin to rise again. Schwab, for example, gets 35% of its income from interest, and the historically low rates aren’t helping. The Fed has said that it intends to keep rates at record lows for the next few years, so this could produce double-digit growth for brokerages once interest rates go on an upswing at some point beyond 2015.
The bottom line is that if you don’t have money to speculate with, stay away from brokerages. The stable, solid candidates are simply too expensive to warrant a long-term investment and there are better opportunities elsewhere in the financial sector.
However, if you have room in your discretionary portfolio, E TRADE Financial Corporation (NASDAQ:ETFC) may be worth a look. When the dust finally settles from their lending mess, the market will realize that E-Trade has built truly the best brokerage platform and the clientele that goes with it. While the long-term viability is far from certain, I think E-Trade has a favorable risk-reward ratio that could pay off handsomely for those willing to take a chance on it.
The article This Brokerage Is Cheap But Risky originally appeared on Fool.com and is written by Matthew Frankel.
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