E*TRADE Gets a Break

In what's become a theme this earnings season for financial stocks, E*TRADE (Nasdaq: ETFC  ) posted estimates-trouncing first-quarter results that were distorted by a special one-off charge. Nonetheless, the discount brokerage still managed to improve notably over its previous quarter. More critically, the company turned a healthy profit, something it hasn't done too often in the course of its rocky history. E*TRADE competes in a tough business, so it has some distance to go before it really takes off.

Thank you, Mr. Tax Man
Analysts were expecting around $0.09 per share in profit for E*TRADE; imagine their surprise when the company posted $0.22 instead. That looks amazing, but $0.09 of that $0.22 was due to a tax benefit thanks to IRS deductions that weren't previously in force.

Such single-item distortions have been prevalent this earnings season for financials, what with Bank of America's (NYSE: BAC  ) earnings getting sapped by $4.5 billion on what was essentially an improvement in its own debt. Closer to E*TRADE's investment-banking home, Morgan Stanley (NYSE: MS  ) got hit with a similar markdown, to the tune of $2 billion. Without that punch to the gut, the bank would have been profitable to the tune of $1.4 billion.

Getting on its feet

Regardless of the nice break it received, E*TRADE's results were encouraging. Stripping out the tax benefit puts EPS at $0.13 per share, or 30% above what analysts had expected. That totals out to net profit of $62.6 million for Q1, a nice about-face from the $6 million loss of the previous quarter and a nearly 40% rise from Q4 2011's bottom line.

Other metrics provide more fuel for optimism. With America's housing and debt crises subsiding, the company relaxed its provisions for loan losses; the amount dropped 41% quarter on quarter and at nearly the same level on an annual basis. This is particularly encouraging, as a bad loan book can easily whack profitability for even the mightiest banks. Maybe this is a start for E*TRADE, an encouraging sign that it intends to move away from lending.

A tough crowd
E*TRADE's starting to do quite well, but since discount broking is a sector crowded with strong competitors, it'll have to do better. Even with that happy tax gain included, its net margin was only around 13% -- several percentage points shy of Charles Schwab's (NYSE: SCHW  ) most recent showing. It is also well below of the 20%-plus margins routinely delivered by TD AMERITRADE (Nasdaq: AMTD  ) , a track record that even includes the relatively weak results that company posted in its latest quarter.

It's good that E*TRADE seems to be fixing its loan portfolio and getting back to brokerage basics. If it continues to improve, maybe in the future it won't need a big tax break to post impressive net profit numbers.

Meanwhile, we've identified a few promising financial stocks. Want to learn more? You can download our free report.

Fool contributor Eric Volkman owns shares of TD AMERITRADE. The Motley Fool owns shares of Bank of America. Motley Fool newsletter services have recommended buying shares of TD AMERITRADE and Charles Schwab and creating a bull put spread position in TD AMERITRADE. The Motley Fool has a disclosure policy. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


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