Teething Pain at E*Trade

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The "E" in E*Trade (Nasdaq: ETFC) probably stands for "electronic." It most certainly doesn't stand for "empty."

The discount broker delivered a rough second-quarter report last night. Net revenue fell by a sharp 20% to $532 million. The company posted a wider-than-expected deficit of $0.19 a share, a far cry from the $0.37 a share it earned a year earlier. However, like the company's iconic trading baby in its recent wave of televised ads, you can't judge this company by the aroma of its diaper.

The sluggish broker continues to bounce back after last year's financial debacle. During the quarter itself, E*Trade reduced debt, sold non-core assets, slashed expenses, reduced exposure to undrawn home equity lines, and actually grew its user base.

It seems those memorable baby ads are working. The company closed out the three-month period with 22,000 more retail customers -- and 30,000 more retail accounts -- than when it started.

Daily average revenue trades fell by 5% sequentially, but actually clocked in 7% higher than last year's second quarter. True, rival TD AMERITRADE (Nasdaq: AMTD) posted much healthier client trading activity numbers last week, while bellwether Charles Schwab (Nasdaq: SCHW) came through with a refreshing top-line spurt that E*Trade still can't touch. Then again, E*Trade's peers aren’t trading at value-meal prices.

E*Trade is paying the price for digging too deep into mainstream banking, but it's also been unlucky in its own trades. The company will take a charge during the current quarter, after cashing out of most of its preferred equity positions in Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE) at a hefty loss earlier this month.

The stock took an after-hours hit on the report, as the company warned that it may not return to profitability from continuing operations later this year, as originally expected. That's good for a smack or two, but I'm keeping my eye on the retail brokerage growth instead. E*Trade will get things right on the way to the bottom line. Future asset hits will always be a risk. However, as long as the company keeps signing up more retail users than it loses, E*Trade will grow in relevance.

If growth continues and the stock doesn't follow, isn't it just a matter of time before TD AMERITRADE, Schwab, or any other financial-services heavy looking for a little skin in the discount-brokerage game gets won over by the E*Trade baby and its toddler-sized share price?

Hang in there, E*Trade. Just make sure you keep clean diapers handy, in case the next few quarters remain a bit on the messy side.