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Future Looks Bright for Online Discount Brokerage Firms


Their balance sheets are vastly improved, they have broadened their product lines, and as outliers, online brokers are potential takeover targets.

Charles Schwab (SCHW), Ameritrade (AMTD), E-Trade (ETFC), and even Interactive Brokers (IBKR) have all seen their shares rise some 17% to over 40% year-to-date in 2012. Many are now trading at two- to three-year highs, and Ameritrade, in fact, is within 13% of its all-time $21.50 closing high recorded on April 21, 2006. Yes, it is now just 13% from the height of the bubble price. Does this positive price action portend well for future gains? Let's run down some positives and negatives across the sector.

Riding the Rally and Clicking Tickets

Rising stock prices, and the few real alternatives, have forced investors to increasingly, nervously reallocate out of fixed income and into equities. It has been slow, but may finally be building steam.

As customer assets increase, whether through new account deposits or as the effect of higher stock prices, the companies' top and bottom line benefit. According to Institutional Investor, every 0.25% increase in UAM results in a 1% boost to gross profit margin and a $0.03 increase in earnings per share. And if customers' cash continues to make its way off the sideline and onto the playing field, it will boost the all-important trading revenue. Plus, if the firms could get to a place where advertising, which now runs some 25% of SG&A, could be reduced, earnings could ramp even further as long as the market co-operates.

Not Quite a Bull's-Eye, but Improving

The most basic metric is DART, or Daily Average Revenue Trades -- that is, how many revenue (commission-generating) trades get executed per day. During the August to November 2011 period there was a precipitous decline. But things are looking up in the first two months of 2012 as Schwab, Ameritrade, and E-Trade all saw increases in new accounts of around 8%, and trading activity increase at the 9%-11% level with trends improving as February came to a close. Overall brokerage and exchange volume doesn't indicate a big rush back to the bubble trading days, but that's not something any one of us really wants to revisit.

If the market can continue to deliver solid and steady gains, retail investors will ultimately drift back to investing in equities; if they don't get caught up in hoopla, they present the best and most stable asset class around. And for the discount brokerage firms (for whom that name is now a misnomer in that they provide a broad line of financial services at good prices), the future looks bright. Their balance sheets are vastly improved, they have broadened their product lines, and as outliers, firms like Interactive Brokers and E-Trade are potential takeover targets.

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No positions in stocks mentioned.

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