With the recent dip in the stock price, TD Ameritrade (NASDAQ:AMTD) becomes an interesting way to play a rebound in the stock market. The online brokerages have produced meager results in the last few years in part due to low-interest rates and that environment could change in the next year.
The quarterly results beat estimates, but the stock now trades at lows as expected rate hikes this year start to disappear. The stock is now at $28, down from $38 in early November when rate hike expectations were rampant.
The primary reason that rate hikes matter is that Ameritrade gets over $380 million per quarter in spread related revenue. The amount is a large piece of the $812 million generated for Q4. The interest revenue is big part in why the brokerage generates operating margins of 42%.
Whether this lasts or not in this volatile market, Ameritrade increased the interest rate sensitive assets by 9% over the last year. The combination of more rate hikes and higher asset balances sets the online brokerage to drive earnings higher.
The primary methods are from an immediate hike in the margin lending rate on January 1 and earning higher rates on interest earning assets while the client gets paid the same rate. The below slide highlights the benefits of higher rates to the company. A 25 basis point hike like in December adds $0.08 to $0.12 to EPS over the next year.
Source: TD Ameritrade FQ1'16 presentation
Clearly Ameritrade is one of the best ways to play a rising rate environment. The online brokerage has successfully increased the asset base while awaiting for the eventual rate hikes.
The only major problem to the bullish scenario is that the Federal Reverse might not actually hike rates this year. At the same time, the turmoil caused in the market by the suggestion of rate hikes will hurt the transaction based business and reduce asset balances.
Investors shouldn't chase the stock on rate hike expectations, but the recent slump likely provides a great opportunity to wait out the eventual rate hikes. Without rate hikes, Ameritrade is solidly profitable and can continue using excess cash to repurchase shares and pay the 2.3% dividend. With rate hikes, the company will see earnings surge and push the stock higher.
The recommendation is to buy TD Ameritrade on dips.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in AMTD over the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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