Here's a fairly simple investment premise: if the stock market
rises +10% or 15% in the next six months, one sector will rise +30%
or even +50%. That's because a rising stock market tends to bring
out increased interest from individual investors. And they bring
lots more business to online brokers. Indeed, I just wrote how
individual investor sentiment is now at
its highest level in nearly four years
, and these folks are getting bullish simply because the market has
been on the rebound since late August.
Need more proof? The major online brokers just reported an
impressive sequential spike in trading volume, as measured by Daily
Average Revenue Trading (DART).
E*Trade (Nasdaq:
EFTC
)
and
TD Ameritrade (Nasdaq:
AMTD
)
just saw +14% to +15% sequential spikes in October, while
Charles Schwab (Nasdaq:
SCHW
)
,
Interactive Brokers (Nasdaq:
IBKR
)
and
TradeStation (Nasdaq:
TRAD
)
saw mid single-digit sequential increases.
Then and now
Two major changes have taken place in the decade since individual
investors were a major force in the market. On the one hand, DARTs
are well below previous levels, despite the recent monthly
uptick
. But all of the firms have many more accounts then they once did
-- in fact, all of the online brokers have at least +30% more
clients than they did at the end of 2007. So, if individual
investors start to become more active (though still below the
levels of the dot-com boom), then DARTs would soar, and so would
sales and profits for these firms.
It's too soon to call October's DARTs the start of a trend. The
metric surged in the spring but had been on the wane thanks to the
market swoon this summer. And though October trading activity was
higher than September's, it's still well down from the spring peak.
But if the recent bullish individual investor sentiment continues
to stay aloft (
which
you can track here
), then DARTs are likely to rebound in tandem, perhaps back to
levels seen last May. Yet the analysts that follow the industry are
unlikely to report on such bullishness until the data come out.
That's why you should track the investor sentiment by the week
instead of waiting until the middle of the month to find out how
the previous month fared.
And you need to ignore industry analysts completely if you are
really to see the big picture, which as noted earlier, is all about
a bulked-up client base at each of these firms. Let's take Charles
Schwab as an example. The company picked up roughly 350,000 net new
client accounts in 2008 and another 300,000 in 2009. Yet Schwab's
revenue is barely growing thanks to a combination of relatively
light trading volume this year and smaller interest spreads on its
fixed income products. But if you assume that Schwab's revenue per
customer will rebound in 2011 to 2008 levels, then Schwab's sales
would spike roughly +30%, and per share profits would likely rise a
lot more than that.
The forecasts don't incorporate such an outlook just yet. Schwab is
expected to generate $4.7 billion in revenue next year, roughly -7%
below 2008 levels, even though Schwab's client base is now roughly
+20% to +25% larger. Looked at another way, analysts think Schwab
can earn roughly $0.80 a share this year, but if DARTs rebound in
2011 and interest rates rise in 2012 (which boosts Schwab's profit
margins), then you're probably looking at
EPS
much closer to $2.
For long-term investors, it pays to see how Schwab's shares have
responded to previous upturns in trading. Shares fell -45% in 2001
and another -30% in 2002 before the company saw a rebound in
operating trends. At the time, Schwab saw
net income
, which had surpassed $700 million in 2000, fall to around $100
million in 2002. By 2007, net income had surged all the way to $2.4
billion. Although it took a while for shares to respond, they
finally rose more than +20% in 2005, more than +30% in 2006 and
more than +40% in 2007.
A similarly bullish long-term case can be made for E*Trade. Right
now, E*Trade is barely profitable, expected to eke out a few
pennies in profit this year. Per share profit should exceed $0.50
next year simply because the company's ill-fated move into
mortgages will no longer be a drag on the company by next year. The
company has also seen a solid rebound in the size of its client
base. And by math, if those clients boost their trading levels by
+15% to +20% next year -- not inconceivable in light of rising
investor sentiment -- then E*Trade's
earnings per share (
EPS
)
could come in closer to $1. The outlook for 2012 and 2013 would be
brighter still if the
bull market
continues.
Action to Take -->
If individual investors get off the sidelines and back into the
market, these companies could become profit powerhouses. If weekly
investor sentiment stays high in coming weeks, you may want to get
in on these names before the analysts start to upgrade their
ratings.
-- David Sterman
David Sterman started his career in equity research at Smith
Barney, culminating in a position as Senior Analyst covering
European banks. David has also served as Director of Research at
Individual Investor and a Managing Editor at TheStreet.com. Read
More...
Disclosure: Neither David Sterman nor StreetAuthority, LLC hold
positions in any securities mentioned in this article.