Online Stock Trading Companies: Buy, Sell, or Hold

Sam Subramanian PhD, MBA

The third quarter was a good one for investors. The S&P 500 gained 15% as stock price volatility declined, risk appetite rose, and confidence in financial markets seemingly improved - a milieu in which online stock trading companies should normally thrive.

However, earnings reports from leading online trading brokers Charles Schwab (SCHW), TD Ameritrade (AMTD), and E*Trade Financial (ETFC) portray a different story.

Charles Schwab: Daily average revenue trades (DART) at the largest U. S. online brokerage declined 9% in the quarter causing Schwab's trading revenue to fall over 4%. The online stock trading company also waived $78 million in fees from its money market mutual funds in the third quarter. These factors caused SCHW's quarterly revenue to plummet 19% from the year-ago period to $1.0 billion.

TD Ameritrade: Lackluster revenue growth and rising expenses chipped away Ameritrade's profits. AMTD's acquisition of options-trading specialist thinkorswim helped trading activity to increase 35% and trading revenue to soar 38%. However, the online broker's overall revenue grew just 1% to $658 million as low interest rates reduced income. This combined with higher expenses from the thinkorswim acquisition lowered AMTD's profits by 9% from a year ago.

E*Trade Financial: E*Trade's daily average revenue trades increased 7% from the year-ago period helping quarterly revenue to increase 52% to $575 million. However, damage from the housing debacle and credit crisis took a toll on ETFC's bottom line. The online broker took a massive $773 million charge in connection with the $1.74 billion debt swap program. These losses compounded operating losses to push the bottom line to a negative $832 million.

Are Online Stock Trading Companies, a Buy, Sell, or Hold?

The outlook for online stock trading companies is starting to improve. Third quarter GDP data point to the end of the recession. Countries like Australia and Norway have raised short-term interest rates. Although there are concerns over the strength of the economic recovery in the U. S., it is conceivable that the Federal Reserve may raise short-term interest rates in 2010. This should remove one of the negatives affecting online broker earnings. If trading volumes hold up or increase, online brokers can improve their earnings in 2010.

As for specific stocks, investors can nibble and start to build positions in AMTD and SCHW. These brokers stand a good chance of posting positive earnings comparisons starting with 2010's first quarter. ETFC may break-even in 2010 and its shares have takeover appeal. However, given weak finances, ETFC shares are suited only for the most risk-tolerant investors.

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