Online Brokerage Wars Are No Laughing Matter

Online broker Ameritrade has a reputation for entertaining television ads. So, too, has rival E-Trade. But their stocks have turned in less-than-amusing performance.

Just look at how these brokerages performed after reporting results that exceeded even the most optimistic expectations. In the first quarter, Ameritrade netted 306,000 new accounts — nearly equal to the 332,000 new accounts it tallied in all of 1999. Still, the stock price dropped — along with the rest of the Nasdaq — about 18 percent to 14 1/2 the day after earnings were announced. Ameritrade closed today (Tuesday, May 9) at 14 1/4. E-Trade added 603,000 new accounts in the quarter, up from 330,000 in the previous quarter. Its average number of daily transactions, 229,000, was 73 percent greater than the 133,000 it averaged in the previous quarter. Its stock price was 22 3/4 before the report, yet it closed lower today at 20 3/4.

Making matters worse, Lehman Brothers downgraded Ameritrade last week from an outperform rating to neutral status. The move came in reaction to the stock’s poor performance despite the company’s strong report. Analysts also anticipate that trading volumes will decline over the next two quarters.

That, however, only partially explains the slump. Online brokerages are in a war to nab accounts. Ameritrade, for example, is currently luring investors with a 50 percent break on the commission fee for one month if they open a cash account with $500 or more. You’re limited to 25 trades, but it’s an attractive deal. The idea is to hook new investors and keep them through the golden years.

But there’s a flaw in the strategy. A recent report on day trading from Bear Stearns pointed out that unsophisticated investors may migrate from value brokers like Ameritrade to “semi-professional trading centers” with more advanced technology as they expand their portfolios.

Competition among online brokers has also intensified as established companies like Merrill Lynch and Schwab jump aboard the online train. While E-Trade has added market research with its E-Offerings analytics, it still does not have the same weight or depth of research as the larger houses, nor can it — or other Net-only players — draw from the large client base already established by Merrill Lynch or Schwab.

In some ways, the online brokerages have been their own worst enemy. Early on, E-Trade and Ameritrade suffered from technological breakdowns that caused high-profile outages, thus irritating investors who were not only trading online but also buying their stock.

With the stocks trading at levels not seen for more than a year, the downside may be limited unless the rest of the technology sector sees another wave of selling. But if you still think these companies will soon mint money for you, wait to buy until later in the summer, after the market goes through its typical trading slowdown. For now, enjoy the ads but stay clear of the stock.

Posted by on May 9, 2000