E*Trade's (ETFC) management is doing a superb job in correcting the errors of the past and bettering the firm's position for the future. Through of a series of brilliant marketing campaigns (i.e. funny baby commercial) and creative initiatives (global trading), the company has managed to retain its retail client base. The April activity report was surprisingly bullish, as average revenue trades were up 5.8% year over year while the stock was trading at 6 times its current value. While management has disclosed that further writedowns and capital dilution may quite possibly occur, these low expectations will play to ETFC's advantage rather than disadvantage from a trading perspective.
Shorts have overstayed their welcome in this name, currently standing at ~23%. As evidenced by the price action in Fannie Mae (FNM) in the first week of May, namely when it announced a massive writedown followed by a significant pop, blindly shorting financials doesn't work anymore. The large short interest in this name should encourage, rather than discourage, investors as shorts naturally have short investment horizons and become increasingly impatient and distrustful of each other as their strategies don't work. The stock currently has resistance at the $6 level; look for it to get off to the races if it manages to break through as there will be a massive short covering induced rally that could easily send the stock back to its October-November level.
So why am I so convinced that E-Trade, a firm that still holds some toxic paper, is primed for a major breakout? First of all, there has been very significant insider buying from various executives at an average weighted cost that equals or exceeds current trading prices; I like the fact that management outs their money where their mouth is.
As evidenced by the April activity report, E-trade has been able to retain its retail base throughout this crisis and should be able to gradually regain some of the customers who defected to other brokerages. The company's global trading platform is truly revolutionary and unique as it allows customers to trade in a variety of global markets in local currencies. The firm has more financial flexibility due to the fact that is also operates as a quasi bank, although I do hope they have learned their lesson and will refrain from investing in risky assets from now on. Citadel's $2.5B cash infusion (at $4.78 per share), while being a bit dilutive, provides for a strong floor.
By betting against a company with rapidly improving fundamentals, the shorts are in effect digging their own graves. Analysts have been known to be too late to the party, whether it be to the downside or the upside. 21 of 23 analysts who currently cover E*Trade have a negative or neutral rating on the stock; that is actually a positive rather than a negative, as I expect a wave of recommendation upgrades in this name that will send the shorts panicking for the exits.
In conclusion, from a risk-reward perspective ETFC looks quite compelling and I look for the stock to break through its resistance at $6 and probably trade back in the mid teens by the end of the year.
Disclosure: Author has a long position in ETFC
