The Online Brokerage Wars: E*Trade Offers Compelling Risk/Reward

One of the most competitive spaces right now must be the online brokerage business. It is to be expected: it is an industry with relatively low barriers for entry and a huge potential market. As the stock market is democratized by the power of the Internet and its abundance of quality information, the need for full-service brokers is dwindling.

This is not new, and the process has been going on for years now. Yet, full-service brokers still have significant number of customers who the online brokers are constantly vying for. Likewise, new generations of would-be investors join the mass of potential customers each year as thousands of young professionals with an independent, entrepreneurial mindset enter the job market and need to decide how to invest their newly acquired disposable income.

Online brokers invest intensely in advertising and promotions trying to gain these available new customers, and of course, steal a few from the competition. This massive investment and ferocious competition keep their margins razor-thin. In this situation, is it wise to invest in an online broker? If so, which one, if any, is poised to win the online broker war?

The three front-runners in this race are Charles Schwab (SCHW), TD Ameritrade (AMTD) and E*Trade (ETFC). Their trading platforms, fees and quality service can be considered quite similar in principle. What will determine then which a potential customer will choose? Here is where building an emotional connection with target customers becomes crucial. In a market where the tangible products or services being offered are quite homogeneous between competitors, creating a sense of rapport and shared values becomes the angle that can make the difference for a consumer.

Each of the three key brokers is trying to achieve this affinity of values in different ways. TD Ameritrade is sticking to Sam Waterston as its spokesperson and trying to leverage the independent spirit of America as their guiding value. This approach, in my view, has limited appeal among young, truly independent investors. It positions investing as a fairly stern, mature and conventional endeavor. That does not resonate well with the right-brained nature of the current generation of customers (for a great book on this, I suggest Daniel Pink's A Whole New Mind: Why Right-Brainers Will Rule the Future).

Charles Schwab hit a home-run with the launch of its "Talk to Chuck" campaign. What a dramatic repositioning for the company! The pioneer of the industry had been losing ground to other online brokers after the retirement of its name-sake founder. The new management at that point lost its sense of direction and tried to take the company to play with the big boys… exactly the opposite of what had made the company successful in the first place! When Charles Schwab returned at the helm, he realized that the company had lost touch with its customers and had created a stodgy and outdated image for itself. "Talk to Chuck" was a vibrant and energetic way of re-humanize Charles Schwab.

From the emotional perspective, I think Schwab is in the best position in its history. "Talk to Chuck" is a warm, fun and irreverent campaign that makes the company approachable and dynamic. However, Schwab might be missing an opportunity: their recent commercials are still talking to sophisticated investors. Their strategy is still about switching consumers from the full-service brokers. In its commercials, Schwab's "customers" invariably explain how the service they got from their previous broker didn't match their own sophistication and knowledge. This communication may be irrelevant for investors that don't feel to be as experienced and, dare I say it, wealthy as the ones portrayed in the ads.

Finally, there is E*Trade. This company was firing on all its cylinders until it got badly hit by the sub-prime meltdown. Its competitors didn't wait to take advantage of E*Trade's woes, and in just a matter of weeks, they stole thousands of consumers and billions of dollars from the company. Even in the midst of the crisis, E*Trade did not lose sight of the importance of communicating with its customers and the reassuring power of advertising. Despite its hemorrhage of liquidity and its internal shakeout, the company upheld its plans to advertise in the Super Bowl. E*Trade's famous "Trading Baby" TV ad was enough to assuage the consumers' jitters and is credited with stopping the bleeding.

In terms of understanding consumer values and position itself as the right complement to their lifestyle, E*Trade does the best job of all three. Their approach is plain, simple and straight-forward. They focus on the simplicity, power and excitement of trading, and are able to let the consumer know that they understand the emotions they are going through in navigating the stock market world: from the father making his first online trade surrounded by his family, to the dude that trades while fragging his friend in "Gears Of War" (very insightful!). These are real people and E*Trade is there with them. Not above, not ahead, but at their side.

Online brokerages will continue to be in an intensely competitive industry in the foreseeable future, and the fierce fight to gain customers will continue demanding huge investments that will keep its profitability in check. Nevertheless, I think E*Trade presents a very compelling risk-reward proposition right now. The stock price is still depressed after the credit crunch scare. While I think their financial situation is still fragile, management is doing the right things to refocus the business and gain new customers. All reports indicate they keep opening new accounts at a vigorous pace. I am not surprised. I think E*Trade has a strong brand equity and they know how to leverage it among the segment of consumers that represent the highest potential for gains. I think the bottom for E*Trade is in the past, and for the patient investor, this could be a rewarding investment. Something to consider for your portfolio; who knows, soon you may even get to rent your own clown.

Disclosure: I own shares of ETFC.

Comments

[User 197828]

good

[0ldman]

clear and direct to objectiv

[Terry Finn]

I currently have accounts at all three brokerages, but I am only trading with two of them, Schwab and Ameritrade. Why did E*trade have such sizable loses from the sub-prime mess when the other two brokerages didn't? I attribute it to poor management at the top and simple greed. When the word got out about E*Trade's financial troubles, I baled on my positive stock positions with them and cashed out. This caused me to have to owe higher short term capital gains taxes instead of lower long term capitol gains taxes. I now owe $100,000. plus in additional taxes due to E*trade foolishness and greed. Maybe E*trade will reimburse me for my tax loss, but I'm not holding my breath. I also understand that when you swim with "SHARKS" you can get bit. OUCH!

[Medici]

Options are the best way to play recovery in this stock-

[kappa]

Go Scottrade!

[smyers]

To Terry Finn - I think you could have simply transferred your ETrade account to either Schwab / Ameritrade and avoided cashing out and getting hit with the 100,000 you said you owe in capital gains taxes.

[Cindy Reed]

The "short position pressure" on this stock, the ongoing successful brokerage metrics, and the strength of their cash/capital position as the turn around plan has been executed place tremendous upward pressure on this stock price. Those who hold their long position have minimal downside risk and huge upside potential. The stock price still lingers in the "bankruptcy" price range and yet since April it has been obvious that bankruptcy is not an issue any more.

[Cindy Reed]

Rafael forgot to mention the global trading ability in E*Trade. Also, the stability of E*Trade's platform execution in comparison Ameritrade, especially since just last week Ameritrade had glitches that significantly stalled out their clients trading causing losses and client anger. In this day of electronic services you just don't let that happen.

[JimmyGoodwin]

Agreed, I'm throwing all the money I can find into E*Trade at the moment, could *pop* any day now =)

[oregonduck]

100,000 in cap gains taxes? If you owe that much and have that much money, you would have known about the right to transfer your account without selling stocks. Shorter exposed.

[rl]

so maria,

what's your projection on etfc in the near term to 2 years?

[704RE]

$100,000 additional huh...Let's use some round numbers to determine what that means...
If by cashing out you incurred an extra 100k at 30% as opposed to the 15% you would have expected:
1) Less than one year ago you deposited over $2,750,000 into your Etrade account.
2) You managed a 20% return in under a year
3) at this point you are sitting on ~$650,000 of gains.
4) You withdraw early and owe ~$195,000 in taxes, as opposed to the ~$95,000 you expected to pay had you held for a year.
I'm not buying it

[oregonduck]

No one who pays that much in taxes--unless they are a lottery winner with no financial ability--would sell their entire position, pay a bunch of capital gains, just to move their account. That is why this did not happen.

On another note--I sense somthing is in the works, like another company buying etrade. Why wouldnt you? Wells Fargo for instance...8$ share.

[anastos]

Banc of America Investments!!!! The portal sucks, there's no research and the only reason I use it is because my friend works for them and I trade for $0/up to a zillion shares of anything. If I didn't have access to industry research through work, this would be the most useless online brokerage service, EVER.

Oh, and I own some etfc and am wondering if I should buy more. It's a small position but the price can't get much worse given the information we're hearing about their operations....

[Shane]

Nice angle Rafael,

Totally agree; ETFC "gets" advertising.

Seeing their banner ads plastered in every corner of the net is one of the main reasons I bought in - most companies are wimpering in the corner when they're down. But these guys are out there sellin' it. And it's paying off.

[The RealExpert]

"Talk to Chuck"???? Successful? Are you nuts? have you ever tried talking "to Chuck"? All you get is some young kid who is clueless and reads from a piece of paper. You can't get more clueless than a discount broker and Liz Sonders is a clown.

People let me cue you in on something about Schwab. Early in 2008, I contacted Schwab and offered to speak at one of their active trader meetings (for free) at the upcoming event (which was 3 days before Bear Stearns was bailed out).

I wanted to help people because I was one of only a few of the people in the world who predicted all that we see today and wrote about it in a book a few years back.

I knew that the media was not really telling people what was going on in the banking collapse and felt that the most important thing would be to provide some guidance and risk considerations to these Schwab clients (since I knew they were 100% lost).

When I went to this event to meet up with key contacts, I was shocked to see that the event consisted of mostly elderly people and the seminars were beginner level - they were teaching the elderly the basics of technical analysis and other things. I was shocked! I wondered, WTF is Schwab doing suckering in desperate elderly people into the most dangerous period of the market now?

Surely they would be having an expert speaker to discuss the current banking crisis, wouldn't they? Not at all. The whole day it was ignored as if it did not exist. They had some guy from one of the lame duck shows on CNBC speak during lunch. And although many in the audience had specific investment questions regarding oil, banks, Bear Stearns, real estate, gold and so on, this fellow was unable to give any decent advice - reason? Because he was clueless. He is on CNBC - what do you expect? Those who appear regularly on TV have no clue what is going on. They are marketers and entertainers.

After following up with Schwab officials the following week, I was sent to some kid who was in charge of these events. He did not bother to even call me...he emailed me with the response..."sorry but we have speakers booked through 2009."

Of course what I was offering (for free once again) was to help guide investors through the current banking and real estate mess NOW, not after 2009. All of this proved to me that Schwab is a complete joke, and no better than the other discount brokers, which are much much worse than the REAL Wall Street brokers.

My advice? Stay far away from Schwab. They are very dangerous because they try to position themselves as advice providers when they are complete idiots. All you have to do to confirm this is call one of their reps and ask for market guidance. They will read off the list of BS they have been told to push "stay invested, think long term, diversify." Wow real valuable. But do not dare ask about options unless you are ready to assume the risk of getting wrong information as I have.

I'd stick with e-trade. At least they don't pretend to offer expert advice and fail to deliver. Always stay away from deceptive people/companies and Schwab is as deceptive as they come in my opinion.

As far as investing goes, why risk investing in any financials when there are so many better opportunities out there. if you aren't in oil, gold, other commodities, China and Latin America, you're just lost.

[The RealExpert]

Call Schwab and ask them why they refused to give any guidance during the current banking crisis to the active trading seminar crowd?? Ask them why they continue to sucker old folks in by making them believe they can "do it themselves."

Listen to me kids. You Cannot do it yourself. You will lose. Trust me, unless you are following someone who is really sharp. And you certainly aren't going to find that person on TV or the financial publications. They are all meant for the sheep. Your best bet is to stick with commodities and emerging markets for the next few years.

[Wez]

Yea sure "expert" because commodities and emerging markets can go parabolic forever.

[Long timeEtradeCustomer]

I have had an account with Etrade for over ten years. I can say I have never had a problem with them. I also had a Home Equity Loan with them,I paid mine back in full, (cant blame me). When I opened my loan I found their lending practices quite conserative, they did a lowball appraisal of my property ,full income documentary etc. This is why I was surprised to hear them in loan trouble, but I supposed they purchased a lot of loans others originated. I wouldnt be surprised if the loans they hold perform a lot better then the doom and gloomers say they will. But I am an optimist, I also think this housing downturn is going to be a memory real soon.Could you imagine what this stock would do if that happened? With the Brokerage gaining customers the loans making money instead of sucking the Company dry it would be one hot stock. Thats why I am long ETFC,and I am not saying it will happen overnight It is sure to a long road back.

[dan-o]

why does everyone keep talking about the "talking baby" ads? Personally i found them to be a bit immature and gimmicky but apparently people liked the little guy, so who am i to judge?

my real question is what happened to the follow on effort designed to capitalise on the apparent success of that ad campaign? etrade is almost non-existant when it comes to TV advertising. Chuck and amtd both have substantial TV ad campaigns and, guess what, both have millions more customers than etrade.

Everything for etrade hinges on its return to profitability. many factors that will contribute to this are largely out of their hands. they can't put people back to work or pay their bills for them. but what they can do is aggressively grow their customer base, which will grow revenue and offset many of the losses they have provisioned for. to do this they need to be on TV.

[methusalaw]

Mr. Finn, sorry that you had to pay additional taxes because for your exodus from E*Trade after the declaration and fear spread. However, as you stated, it was your decision to leave E*Trade due to your insecurity and non-DD. E*Trade did not leave you. Now E*Trade is stronger and well on its way to its previous glory, while you sir are stuck with a tax burden and inferior trading platforms with which to trade. You should own up to the mistake you made rather than blame E*Trade for your shortcomings. I’m sure that E*Trade would take you back and treat you with the same great service and platform as the rest of us customers enjoy. Come on home, sir. By the way, as others have said, why didn’t you just transfer your stock vs. closing out your positions? For someone making as much as you appear to do trading, this was an unintelligent move or are you just a smart short trying to sway retail traders?…hmmmmmmmm.

[methusalaw]

To The Real Expert. I thoroughly enjoyed your comment on Schwab and your experience. If you write articles in SA sometime in the future on this or other subjects, I believe retail investors such as myself would love to read and gain from your knowledge and experience. One article of interest that I would like to read is your perspective on E*Trade's progress toward recovery, especially the company's progress in shoring up its loan portfolio.

[oregonduck]

Call security--The real expert is here and he wants to "speak" at our seminar. lol.

Commodities are high risk and are part of a well diversified portfolio. People that are retired should put their money in bonds and fixed income type securities primarily. Us high-flying 37 year old lawyers with a long time horizon can play the market a bit with higher risk stuff. The reality is that Etrade is my highest risk play right now. I guess sirius would also fit that mark. Actually--the biggest high risk investment is my wife. Divorse is the single most financially devstating thing that can happen to anyone who makes money.

[The RealExpert]

To Wez...gold, commodities, oil and emerging markets don't have to go parabolic forever, nor do i expect them to. But I have been in them for several years now an I will guarantee you they will do well for several more years. When the time comes to exit I will, but until then I certainly won't be wasting my time in US equities (other than shorting the financials after rallies and buying oil). Sounds to me like you are a bit upset that you missed the boat. Stick in their kid. There is still plenty of upside in oil, gold, Latin America and China.

To Oregon duck...."high-fly... lawyers"? Impressive. You apparently know very little about investing to even consider Siruis. I predicted its forced buyout or bankruptcy over 5 years ago due to obvious in that terrible industry with little growth prospects. Why would anyone invest in a company that gives away all of its equity to the CEO and Howard Stern?

Stick to divorce court because you obviously lack the ability to analyze companies strategically. As far as e-trade as an investment, at best it will be many years before teh stock price recovers to previous levels and a lot of sweating bullets from your forehead. You'd be better off in oil, which is certain to go up further. Look at the risk/reward of e-trade vs oil.

The conclusion is obvious. None of you should ever buy any distressed securities. It is the most difficult call to make and can only be done well by the best of the best CONSISTENTLY. While you might get lucky here and there, over time you will get burned net net.

To methusalaw...Thank you. I wrote it thinking I would get attacked as I have when I submitted articles for Seeking Alpha, which I no longer do. The reason is because Seeking Alpha selectively censors submissions as if their staff know more than the authors. I found that they were more interested in created market buzz than helping investors.

As an example, I submitted part 1 of a part 7 series of 2 page articles explaining how the government manipulates economic data. Seeking Alpha did not publish it and gave me no reason. Only after pushing for an answer did they tell me "it was not something that generated investment action."

You tell me that not understanding how the government understates inflation by 200% or overstates GDP, and other things is not important.

In short, Seeking Alpha is a joke and it will NEVER attract and retain real experts like myself - experts that could have warned you all about the catastrophe we see today and in the future - experts who left Wall Street due to the disgust seeing them screw everyone - experts like me who have no vested interests and would like to help investors - because they are clowns focused only on generating a casino mentality for the market. That is why they cover what Cramer says on his show. Why would any serious investors care what Cramer says except for shorting ideas?

[larry l]

stockchart's point and figure chart predicts 10.5 for etfc???

[okletsroll]

To the The Real Expert. I would certainly like to know where your positions are in commodities, oil, emerging markets and gold.

[The RealExpert]

To okletsroll....bullish for many years (as my position has been for many years previously) with the caveat that there will most likely be a correction in commodities by around 2010-2011. From there I expect a strong rebound and strong performance through 2014. Gold may last a few years longer.

If you are stuck in the Dow or other US index, you are throwing your money away. With the real inflation rate at over 10% and the Dow at around 8000 (adjusted for the dollar since 2001), I hope you can see why the US equities (with rare exceptions) will be a poor investment choice.

[jbmaria]

Be very careful with ETFC.
As I see it,there's no guarantee that last Q's noted improvement in the loan portfolio won't reverse.Macro trends in housing and incomes don't indicate to me any clear improvement in the mortgage holders lot,delinquencies and defaults continue to trend upward.And the Fed may be out of bullets.
I don't know how bad it might be or become but ETFC has around $40 Billion in loans that could get in some degree of trouble.
SA author,R. Middleton has written a comprehensive series on the crisis and other articles I highly recommend,read everything he offers if you want to temper your outlook with some intelligent caution:

seekingalpha.com/artic...


Some other cited issues are asset sales,like the Indian deal just announced. OK,they get the $145m but they lose the rev. and profit going forward and this from a co. that recently was selling themselves as an international player.

Further,they will be paying over $50 million per Q interest to Citadel ,a nasty drag on potential profits.

Exiting the mortgage origination biz. Sounds good given the aura surrounding mortgages but recall this was once probably their biggest moneymaker,now gone for the conceivable future.And let's not forget it's expensive to exit a biz line,severance packages and all that.

Debt for equity swaps. Yes,they take debt off the books,a good thing but they are dilutive to shareholders.
And speaking of dilution,keep in mind the recent authorization of 600 million shares by management.
Those pumping ETFC would have you believe that mgt. just ran out of authorized shares for routine corporate purposes like ESOPs and debt for equity swaps.Maybe, but did they need to double the existing 600 million shares,seems like they have something in mind that a more modest 1-200 million shares might not cover.
Curious!

At the same time,Citadel registers for "potential" sale over 90 million shares it got for lending ETFC $1.9 Billion at 12.5 % last November. It also registers this debt for "potential' sale at the same time as the share authorization. Curious!

I'm not going to pretend I know what either ETFC or Citadel is up to but unlike the pumpers I won't assume it's purely coincidental and /or innocent toward shareholders.
If nothing else it adds a huge dose of uncertainty to the equation and we know how uncertainty is treated by Wall Street.
And speaking of Citadel,FWIW,in March a hedgefund manager stated:

"The anonymous fund manager said Citadel, which did not return a call 
seeking comment, paid such a low price for the mortgage book, and got 
such favorable terms on the loan, that it would have been foolish for 
other hedge funds to blindly follow into the stock. After all, he 
said, Citadel was getting in cheap.
"Why would any bull point to Citadel?" he said. "

Frankly,mgt. is another reason I'm wary of ETFC.
Look at the facts.

Layton,according to published reports,was not the BOD first or even second choice for the job.

Layton,to my knowledge, is not known as a turnaround specialist,per se,and he did have some Enron rumors surrounding his former job,perhaps even contributing to his retirement.

To date,the pps has not improved.

Layton is very much at the mercy of KG,who I trust as far as I can throw.

Layton's heavily touted pay package would do best if he succeeds at a turnaround BUT he is getting a $1 million/year cash and will get a nice payout in the event of a buyout and I don't think there's any caveat as to buyout price.This is from memory so you might want to check the filings on that,not that momentous an issue though.

Bottom line,he hasn't been there long enough or achieved enough to rate him so he remains a question mark,IMHO.

I have more concerns but for now I think you can see my caution on ETFC as an investment is quite logical.

[Steve J]

bjmaria,

don't count on ETFC' 30-60 day delinquency' to increase while Uncle Sam is depositing $600 checks into everyone' checking account.

[rigel]

SteveJ, while you may disagree with jbmaria, there is absolutely no evidence that the rebate checks are going to help ETFC. If someone can't afford their payments, I don't see how a one-time bonus of 600 bucks is going to make a lick of difference in the long run.

Just because you are long ETFC doesn't mean you have to make irrational arguments to make you feel better about your position. If you don't understand the risk (and are certain that it's a "sure thing"), assume you are missing something.

Disclosure: Long ETFC

[BioInvestor]

Terry Finn: why didn't you just transfer the holdings to another broker?

[CWF]

I have approx. 2 million in invested funds at ETrade both taxable and SEP accounts. It represents about 70% of my current retirement savings. Am I taking unnecessary risk having all of this invested at E-Trade? I do like their trading platform and research information etc. Would appreciate comments and advice. Thanks.
BF