From today's WSJ:
Heard on the Street
Investor Caution Knocks Wind
Out of Internet Brokers' Stocks
By REBECCA BUCKMAN
Staff Reporter of THE WALL STREET JOURNAL
Blowout online-trading volumes just aren't what they used to be.
Despite a staggering amount of Web stock-trading this quarter by individual investors -- surpassing even the nosebleed levels of the spring -- the stocks of once-highflying Internet brokers aren't keeping pace. They have lagged behind many other Internet stocks that have helped propel the Nasdaq Composite Index to record heights.
The upshot: more investor caution about the prospects of Web brokers, some analysts say.
"You've had a complete disconnect between the Internet index and the online brokers," says Henry McVey, an analyst at Morgan Stanley Dean Witter & Co. "It's almost like online trading's become more passe." Indeed, before a sharp rise Wednesday, an online-brokerage stock index compiled by Hambrecht & Quist had been roughly flat for the past four weeks, while the Dow Jones Internet Index rose 31%.
Hard to fathom, what with the crush of Web trading this quarter and the billion-plus dollars being spent by the industry on catchy advertisements. But even a positive earnings preannouncement from online-trading powerhouse Charles Schwab Wednesday couldn't propel online-brokerage stocks to their earlier, lofty levels: Schwab shares shot up $6, or nearly 18%, to $39.9375 in 4 p.m. trading on the New York Stock Exchange Wednesday. But the stock remains 49% off its 52-week high of $77.50.
Schwab, a more diversified financial-services firm and the nation's largest online broker, expects to blow past analysts' fourth-quarter revenue expectations and post per-share profit of two or three cents above Wall Street's consensus. It benefited from record trading volumes on the nation's stock exchanges, particularly the Nasdaq Stock Market. Average daily volume on Nasdaq could rise 33% by the close of the fourth quarter from the third quarter, according to Hambrecht & Quist.
Similarly, shares of online-only brokers such as E*Trade Group, Ameritrade Holding and National Discount Brokers Group surged Wednesday on Schwab's coattails. But the stocks were nowhere near their yearly highs, reached in April.
"Obviously, these guys have not been the big winners lately," says David Kugler, president of the $160 million Monument Internet Fund, based in Bethesda, Md. Mr. Kugler's portfolio has lightened up its positions in online brokers such as Schwab and E*Trade since April, though it has recently added back some E*Trade and is now looking at Schwab again as a "good value."
What is going on? Bearish Wall Street analysts point to a laundry list of investor concerns, ranging from excessive marketing spending by Web brokers to increased competition from more traditional firms such as Merrill Lynch and Morgan Stanley Dean Witter. Both firms have launched discounted, online trading this year.
Mr. Kugler says many of the stocks simply "got ahead of themselves" during April's Internet boom, and investors now treat Internet brokers as financial companies -- buffeted by boring trends such as interest rates -- as much as Web darlings.
Another theory takes a more cautious view of the very Internet-stock frenzy that is pumping up trading volumes at online brokers. "There's a very close correlation" between online-trading volumes and activity in Web stocks, says James Marks, an analyst at Credit Suisse First Boston.
At Schwab -- the only online broker that releases monthly trading numbers -- average, daily revenue-producing trades soared 25.3% in April as Internet-stock volumes surged 33.7%. The next month, Schwab's trades fell 38.5%, while Internet volumes slid 24.4%.
With regard to Internet stocks, says Mr. Marks: "The question investors have to pose and answer is, 'Do I think that this level of activity is sustainable?' "
He says investors could be concluding that it isn't. The so-so performance of online-brokerage stocks today "may in some ways be a reflection of expected performance in Internet stocks, given that performance in the future" is what drives current valuations, he adds. Mr. Marks currently rates Schwab, E*Trade and Ameritrade as "hold."
Even before Wednesday's surge, shares of Schwab, E*Trade and Ameritrade Holding are still up handily for the year. Steven Appledorn, who manages the Munder NetNet Fund, notes Schwab shares have risen 21%, while E*Trade and Ameritrade shares have soared 120% and 290%, respectively, for 1999. "They're off their peaks, but they're still in pretty good shape," he says.
Mr. Appledorn's fund owns all three stocks and sold some around their peaks in April. But "I've continued to buy these stocks throughout the year," he says.
Still, he adds: "I think even the bulls are a little bit concerned about what the price action is going to be with the Internet stocks early into the new year. I think some of that is what we're seeing built into the prices of these stocks."
San Francisco-based Schwab does more than online trading, of course. The company also has a big mutual-funds business and caters to wealthier clients, who often trade by phone or in branch offices. The average Schwab account has $94,200 in assets, according to Credit Suisse First Boston. That is nearly twice as much as the closest online competitor, TD Waterhouse Group, where average assets per account are just over $56,000.
In the fourth quarter, Schwab expects to have increased its total asset base by about $105 billion, "and we believe close to a third of that is new money," says Richard Strauss, an analyst at Goldman Sachs Group. Schwab now has more than $700 billion in assets and is on track to post record profit margins, Mr. Strauss says.
Says Amy Butte, an analyst with Bear Stearns: "What this shows is that even in the face of increased competition and high levels of investment spending, Schwab is showing fundamental strength."
Ms. Butte says Schwab's stock actually is undervalued, which is why she has a $65 12-month price target on the stock. "You've had a perception on the Street that is dampening the stock prices" of Schwab and other online brokers, she says. But Schwab's announcement Wednesday -- in which the company said it expects to post fourth-quarter net income of 19 cents to 20 cents a share and revenue of $1.1 billion -- shows "hey, these perceptions aren't right," she says.
Schwab posted earnings of 15 cents a share in the third quarter and 12 cents a share in last year's fourth quarter. Though the expected earnings for this year's fourth quarter aren't that far off analysts' mean estimate of 17 cents a share, Schwab decided to preannounce the numbers because "we take our disclosure responsibilities very seriously," spokesman Dan Hubbard said. He noted the firm has issued early announcements seven times since 1994.
Write to Rebecca Buckman at rebecca.buckman@wsj.com
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