E*Trade Primed for a Breakout

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

Comments

[Pauly B]

I have been an E Trade customer and have been very satisfied with their service and platform. As more people take control of their investments on line brokerages will flourish. In the long term E Trade is still a likely takeover candidate as the brokerages consolidate as many have duplication of services. I could see a Schwab or TD Ameritrade buying these guys out in the next few years.

I agree, the shorts have overstayed their welcome here.

2008 May 16 08:26 AM

[Jimmy Goodwin]

Seeking Alpha continues it etrade push, don't fool yourself, this company is bankrupt.

2008 May 16 09:29 AM

[Xyrus]

Improvement? Maybe. Breakout? Unlikely. They could have the best management team, but until their books look better I don't see a whole lot of people rushing to buy, even at these prices. Too risky.

A buyout is possible, but unlikely until they shovel more of the garbage off their books, unless they are bought at lower prices to account for the toxicity.

This one would be a wait and see for me.

~X~

2008 May 16 09:44 AM

[Jimmy Goodwin]

Considering the stock was under $4 a couple of days ago, this is probably the most overpriced stock on the whole market atm. Lets not forget that stock price was $2 a few months ago. It could easy go back to that level and 50% of your cash is gone, for good.

Why would someone invest in a stock which could lose 50% - 100% in a blink of an eye?

2008 May 16 09:53 AM

[lefty]

Agree with Dean. I also have picked up a long position. Will be $10 by end of 08.

2008 May 16 09:55 AM

[igotpaged]

I agree 100% with the writer. ETFC is working in the right direction and becoming a much better forward-looking company. Don't be a fool, just follow the money....

2008 May 16 10:01 AM

[matt7]

Not hard to tell that Jimmy is probably short ETFC and is getting scared...

2008 May 16 10:04 AM

[ZenInvestor]

Shorts beware! This strong platform, with management's newly authorized stock has the ability to swap debt for equity at a discount and with that reduction in interest expense will be profitable in Q3 if not in Q2. They continue to add accounts and have the best platform in the business (I am a customer). Breakout is long overdue and not much sense in thinking this is not a $6 stock and soon!

2008 May 16 10:46 AM

[rl]

i don't think etfc is a takeover candidate, i think etfc is strong enough to takeover ameritrade in about 2 years. the combination will give old chuck a run and tip the scale in favor of etfc. this reminds me of the circuit city vs. best buy a few years ago.

2008 May 16 11:18 AM

[jackooo]

I handle 7 portfolios with E Trade. Most were through Brown Co. when E Trade bought them.
I have pulled one $100,000 plus portfolio because I was not satisfied with customer service. They do not know their jobs and I am continually on the phone trying to set things right. The phone times range from 1/2 hour to a full hour.
Based on their lack of knowledge and lack of expertise I would not venture a buy on their shares.
[e-mail]

2008 May 16 11:35 AM

[User 194600]

6.00 no . ETFC is trading at 4.40 right now on news and the market. Todays stockholder meeting should be reflecting the changes made so far and should be very positive. This alone will take us to 6.00. If positive earnings show up in Qtr2, the gap to 8.00 will be filled. With positive earnings in Qtr3, ETFC could very easily be in the 14.00-16.00 range. Remember in 2003 it climbed from 5.00 to 20.00.
You are looking at a revamped company here with management that seems to know what it is doing. 2 to 3 years from now, with a few purchases under it's belt, it could easily be trading at the high end valuations I have seen, such as 44.00.

2008 May 16 11:44 AM

[prescient11]

Great article, thank you. I look for at least $10 by 1Q in '09 and would be ecstatic with $15. If the first lien loan portfolio falls in line, watch out, this will take off like a rocket.

2008 May 16 11:50 AM

[newcomer]

I used to have a great experience with Etrade supporters. But recently I noticed they have many idiots there. This really gives me a mixed feeling about the company. Hopefully, those are the new-hires, but again you lost your time and most often chances too with those idiots.

2008 May 16 11:59 AM

[Stockpickerforum]

Jimmy Goodwin,

Are you starting to get nervous? You obviously made two comments about the article which quite easily shows that you are short E-Trade and are starting to get a bit more aggressive in your stock pitch. Most overpriced stock?!?!?! Based on what analysis? On how much you've lost by shorting it?!

2008 May 16 12:28 PM

[SeekingAlphaIsFullOfSheet]

One or two bad experiences with customer service? Yeah me too? But hey, at least I'm not getting forwarded to India for my customer service needs. Everyone has to start somewhere. I don't have a problem with people that try. More people should learn the phrase, "I don't know the answer I need to talk with my manager." This does add to wait times. But they do end up getting it right. Eventually.

2008 May 16 12:36 PM

[pshah]

Etrade just announced a doubling of their total shares to 1.2 billion. Can the author or anyone here explain how this dilution is beneficial in any way for current shareholders?

It seems all these long ETFC arguments have some weight but still is a lot of speculation....

2008 May 16 12:59 PM

[ZenInvestor]

The shares are 'authorized' but not 'issued' so there is no dilution at the moment. The stated intention, besides the obvious stock options, etc., in the normal course of business is to 'swap' debt for equity at a discount. They intend to retire 700MM in debt in this fashion. That will reduce their interest expense and speed the return to profitability. They are also selling for cash some 500MM in subsidiaries that no longer fit the long term strategy. If you combine those two events you should have minimal dilutive effect on the stock, AND profits with a more stable balance sheet. All and all, the words and deeds from ETFC have been 'shareholder friendly'.

2008 May 16 01:10 PM

[Go US]

I liked this stock at 2.50 and at 3.80 I just keep buying!!!! I would love to know what the "shorts" have in their pants, I guess no BALLS!!!
Jimmy was figured out so easily. This stock is Stair stepping and looks to be finding resistance at $4.40. I'm not shure if this puppy has leggs even with new management. Risk Vs reward, by the time investors figure this one out it will be all over. The Feds are pumping tons of cash into the system, and the US $ has been in the can so I figure this stock will hit $12.00/ share by years end.

I am Long on ETFC no suprise!!!

2008 May 16 01:18 PM

[Jimmy Goodwin]

"You obviously made two comments about the article which quite easily shows that you are short E-Trade"

I confess, you got me, I went short on a company going bankrupt but it instead it turned into a google overnight, well, according to Seeking Alpha writers anyway. Or perhaps, I just wanted to say something and there was no edit button.

I just posted because I feel quite angry at SA writers who obviously are telling lies in a desperation to reclaim some of the money back they lost when etrade went bust. Also, I feel sorry for potential investors in etrade who stand to lose upto 95% of their money should the predicted bankruptcy happen, this could happen any moment now! Just stick to the facts.. the company is in deep trouble, the stock is now overpriced and extremely risky. As evident in today's trading when it crashed -7% from its day high because of a little bad news. I can't imagine what will happen when the proper bad news arrives. Etrade investors are just over confident because of this excellent rally we've just had, this is not google or apple, this is a company about to be bancrkupt lol.

2008 May 16 01:22 PM

[Zeus]

Jimmy Goodwin - you don't know what you're talking about.

The odds of Etrade trading back to the 2.30 - 2.50 range are slim and none. That was the bottom.

I think the author is also wrong. The truth lies somewhere in the middle.

Etrade should trade higher by year's end, but the idea that this will be a teenager again that soon is ridiculous.

Almost as ridiculous as Jimmy Goodwin's inane prediction.

2008 May 16 02:24 PM