E*TRADE: DOWN NOW, BUT BETTER TIMES MAY BE COMING
Given the current trading mindset of individual investors and the astounding runup in Internet stock prices this year, you would think the shares of E*Trade Group (EGRP), one of the pioneers in electronic brokerage, would have tripled or at least doubled in price so far this year.
Well friend, you would be wrong. Actually, the stock price has hardly budged. E*Trade shares lost more than 50% of their value in the fourth quarter of last year and have remained in the low-20s for most of 1998. The stock closed on Apr. 23 at 22 9/16.
Still, E*Trade's dramatic decline from its highs, sparked by intense competition among online brokers, has created an opportunity for the kind of investor who likes to buy industry leaders at a rocky time. "Near-term, there is a lot of concern about price competition in the industry, and it is difficult for people to get excited about the group," says Piper Jaffray's electronic commerce analyst, Bill Burnham. "Long-term, E*Trade has a strategy in place that can build a very big business."
CUT AND RUN. Burnham attributes much of E*Trade's recent rapid decline to the decision by short-term momentum players -- probably many of the same investors who use the company's service and who drove the stock up in the first place -- to bail out of E*Trade's shares. From the time the company went public in July, 1996, at $10.50 a share, it rose steadily to a high of 47 7/8 in October, 1997.
That's when new entrants in the electronic brokerage business and rampant price-cutting spooked investors in E*Trade. Competitors Ameritrade and SureTrade came out with $8 trades and national advertising campaigns, robbing E*Trade of its status as the price leader with $14.95 trades, says Julio Gomez, president of Gomez Advisors, which rates online brokerages at its Web site www.scorecard.com.
E*Trade compounded the impact by refusing to compete on price, choosing instead to add new services and features. It will unveil a major upgrade to its Web site, Destination E*Trade, in the coming months, is expanding internationally, and recently rolled out a new 24-hour online service center. "They are in a period where they are forsaking the easy money, trying to establish themselves as a brand," says Burnham.
PROMISING FUTURE. While investors panicked, analysts continued to raise their earnings estimates. The company beat fourth-quarter estimates by 2 cents a share and met most analysts' first-quarter estimates. For the first quarter of '98, E*Trade added 24% more accounts for a total of more than 400,000. E*Trade has 14% of the total average online daily trading volume, second only to Schwab's 30%, according to Burnham's calculations. Its revenues in fiscal 1997
(which ended in September), were $143 million, up from $52 million in 1996. Its profits were $14 million, or 40 cents a share, after a loss in '96. For 1998, Hambrecht & Quist expects the company to earn 65 cents a share on revenues of $225 million.
That's not to say E*Trade has an easy time ahead. Revenues have suffered from the loss of payments for order flow -- a kind of commission that brokerages get from market makers for sending trades their way -- because new rules have cut back on those fees. And while account growth has been strong, some analysts note that it has not accelerated as fast as it did in the past.
Still, analysts remain focused on E*Trade's promising future, even though efforts to improve its Web site and services may take a few more quarters to add to the bottom line. "The successful launch of Destination E*Trade, along with customer account growth as well as a relatively healthy market environment, will be critical to achieving revenue reacceleration over the next several quarters," Hambrecht &
Quist analyst Genni Combes wrote in a recent report.
For now, that leaves E*Trade looking fairly attractively priced. It is trading at 35 times its 1998 p-e, yet its earnings are expected to grow by about 50% a year long-term. "The stock trades at a p-e of [1999's anticipated] earnings per share more in line with a lower-margin, slower-growth, telephone-based brokerage firm," Keith Benjamin of BancAmerica Robertson Stephens, wrote in a recent report, as he set a price target of 45. "We believe E*Trade has a leading formula to leverage the Web."
At what seems a very reasonable price for an Internet play, E*Trade offers a way for investors to get in on two of this decade's most notable trends: The growth of the Internet, and the new do-it-yourself trading mentality of investors.
By Amey Stone
Associate Editor, Business Week Online
Copyright 1998, by The McGraw-Hill Companies Inc. All rights reserved.
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