1 Reason to Steer Clear of This Stock


The discount brokerages were some of the great growth stories of the early 2000s, as the growing popularity of the Internet and the evolution of high-speed connections enabled average people to trade stocks in real time at very low commissions. One of the originals and still one of the most popular, TD Ameritrade has seen its revenue quadruple from just a decade ago. It seems, however, that the party may be over for this great company.

Stagnant growth?
Looking at TD Ameritrade's revenue chart for the past decade, we see a clearly defined growth trend for the period from 2003 to 2007.

Source: TD Ameritrade.

Since that time, revenue and earnings have been pretty stagnant, which is surprising, given that TD Ameritrade made a couple of very significant acquisitions during that time. The addition of Fiserv and its $25 billion in client assets, as well as thinkorswim group, which tremendously grew TD Ameritrade's options-trading capabilities, have yet to really impact the company's bottom line.

The problem is that not enough new accounts are being opened and not enough trading is taking place to produce any real growth in profitability. The financial crisis scared a good percentage of the younger generation away from investing in equities, and while it has been reported that money is starting to flow back into equities, it hasn't been at a rapid pace. According to a recent report, about 69% of retail investors' money is in equities, just over the historical average of 68.4%, which indicates mild bullishness but still some skepticism.

Too expensive?
Given that revenue and earnings have been constant for some time now, it may surprise you to find out that TD Ameritrade is trading for roughly 25 times its trailing-12-months earnings, which are expected to grow by about 8% annually for the next few years. This valuation multiple is at the high end of the company's historic range, even compared to the rapid growth era of the early 2000's.

Source: S&P Capital IQ.

Are the others any cheaper?
Since it looks like TD Ameritrade is a little too expensive, let's see if there might be any other companies in the sector worth a look. As far as publicly traded brokerages are concerned, the only two that are comparable in size and business model to TD Ameritrade are Charles Schwab and E*TRADE Financial . Let's take a quick look at those.

Charles Schwab is more of a hybrid company, whose revenue comes from retail brokerage and banking (39%) as well as investment advisory services (40%) and institutional services (21%). Surprisingly, Schwab trades at an even higher valuation of 34 times trailing-12-months earnings -- although the company is projected to grow its earnings at a faster rate, by about 14% annually over the next three years. Even so, I don't believe that such a lofty valuation is called for in an industry that's not growing particularly fast.

This brings us to E*TRADE, which is a somewhat special case. E*TRADE had an awful lot of exposure to toxic mortgage assets during the financial crisis, and some doubted the company would make it. As a result of this and the dilution that ensued from capital raising, E*TRADE's shares trade for a small fraction of what they once did.

Shares of E*TRADE, however, have more than doubled over the past year, and now the stock is looking just as pricey as others in the sector despite the continuing risks involved. E*TRADE is valued at 19 times even the most optimistic forward earnings projections, which makes it the "cheapest" of the three. However, in this case the risks involved from the company's lingering issues that came from the mortgage crisis simply don't match the price.

The common theme among brokerages right now seems to be a high valuation and relatively slow growth. E*TRADE seems to have the best long-term potential, but the company still carries great risk and has already rallied quite a bit this year. The best place to invest at this time seems to be elsewhere in the financial sector.

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The article 1 Reason to Steer Clear of This Stock originally appeared on Fool.com.

Matthew Frankel has no position in any stocks mentioned. The Motley Fool recommends and owns shares of TD Ameritrade. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Originally published