E*TRADE (ETFC) stock is on fire, shares of the direct broker have gained over 73% in the past year. But past performance does not guarantee future returns, and investing decisions should always be made by looking through the windshield, not the rearview mirror.
Backtested data shows that companies with strong attributes in terms of financial quality, valuation, momentum, and relative strength tend to deliver market beating returns over the years.
In that spirit, the following paragraphs will be taking a look at E*TRADE stock in terms of these four key return drivers in order to find out if the best is already in the past for investors in the company or if E*TRADE still offers attractive upside potential going forward.
E*TRADE is one of the leading players in the direct brokerage industry. Consumers around the world are becoming increasingly confortable with the direct-brokerage business model, which offers not only more comfort and convenience, but also substantially lower costs in comparison to traditional brokers.
According to the company, direct brokers are rapidly gaining market share versus the traditional brokerage industry, and direct brokerage players still account for a relatively small 24% of the market, which means that the industry has substantial room for expansion in the long term.
E*TRADE has delivered volatile financial performance over the years, since the business depends considerably on macroeconomic conditions and activity levels in financial markets. But key variables such as revenue and earnings are clearly moving in the right direction.
The company reported record revenue numbers during the first quarter of 2018, with total revenue rising to $708 million, a vigorous increase of 28% versus the first quarter of 2017. Not only that, but key operational metrics such as Daily Average Revenue Trades (DARTs), customer margin balances, and net new brokerage assets also marked new records during the quarter.
Management is expecting adjusted operating margin to be in the range of 44.5% to 45% of revenue during 2018, so profitability levels are quite healthy.
Even after such an impressive rally in the stock, shares of E*TRADE are still reasonably valued by industry standards. The table below shows key valuation ratios such as forward price to earnings, price to sales, and price to book value for E*TRADE versus competitors like Schwab (SHW), Ameritrade (AMTD), and Interactive Brokers (IBKR).
E*TRADE stock is priced at a discount versus its competitors across the three valuation ratios considered.
Stock prices don't just reflect current fundamentals, but expectations about those fundamentals can be even more important. When a company is delivering better than expected earnings and expectations about future earnings are increasing, this generally pushes the stock price in the right direction too.
The chart below shows how E*TRADE stock price and earnings expectations for both the current year and next year have evolved over time. It's easy to see the close correlation between the stock price and earnings forecasts for the company.
On the back of rock-solid performance from the company and encouraging guidance from management, Wall Street analysts are materially raising their earnings forecasts for E*TRADE lately. This is a powerful upside fuel for the stock.
|EPS Revisions||Current Qtr. (Jun 2018)||Next Qtr. (Sep 2018)||Current Year (2018)||Next Year (2019)|
|Up Last 7 Days||9||10||11||9|
|Up Last 30 Days||15||15||16||17|
|Down Last 7 Days||N/A||N/A||N/A||N/A|
|Down Last 30 Days||1||N/A||N/A||N/A|
Outstanding Relative Strength
Winners tend to keep on winning in the stock market. Besides, an investor's available capital has an opportunity cost. When you buy an investment with subpar returns, that money is not available to invested in companies with superior performance. For this reason, we don't just want to buy stocks that are doing well, we want to buy the names that are performing materially better than others.
Most companies in the brokerage industry are delivering strong returns lately, as expressed by a gain of 30.71% for the iShares U.S. Broker-Dealers & Securities Exchanges ETF (IAI) ETF in comparison to a gain of 11.36% for the SPDR S&P 500 Trust ETF (SPY) in the past year.
Importantly, E*TRADE is a king among kings when it comes to relative strength, as the stock has crushed both the broad market and the sector in particular with a vigorous gain of 75.73% over the past twelve months. When it comes to relative strength, E*TRADE doesn't leave much to be desired.
Putting It All Together
The PowerFactors system is a quantitative investing system available to members in my research service, "The Data Driven Investor". This system basically ranks companies in a particular universe according to the factors analyzed in this article for E*TRADE: quality, valuation, momentum, and relative strength.
The system has produced solid backtested performance over the long term. The chart below shows how the 50 stocks with the highest PowerFactors ranking in the Russell 3000 index performed in comparison to the iShares Russell 3000 ETF (IWV) ETF since 1999. The backtesting assumes an equal-weighted portfolio, monthly rebalanced, and with an annual expense ratio of 1% to account for trading expenses.
Backtested performance numbers are quite encouraging. Since January of 1999 the portfolio recommended by the system produced an average annual return of 14.62%, comfortably beating the 6.24% produced by the benchmark. In plain English, a $100,000 investment in the market-tracking ETF in January of 1999 would currently be worth around 322,200, and the same amount of capital allocated to the PowerFactors portfolio would have a much larger value of almost $1.4 million.
E*TRADE is one of the companies currently recommended by the system, and the stock has elevated scores across all of the quantitative return drivers considered: quality, valuation, momentum, and relative strength.
Backtested performance does not guarantee future returns, and this kind of analysts should always be interpreted with caution. That acknowledged, it's good to know that the numbers are clearly pointing towards further upside potential in E*TRADE stock.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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.