Has E*TRADE Financial Become the Perfect Stock?

Every investor would love to stumble upon the perfect stock. But will you ever really find a stock that provides everything you could possibly want?

One thing's for sure: You'll never discover truly great investments unless you actively look for them. Let's discuss the ideal qualities of a perfect stock, and then decide if E*TRADE Financial (Nasdaq: ETFC  ) fits the bill.

The quest for perfection
Stocks that look great based on one factor may prove horrible elsewhere, making due diligence a crucial part of your investing research. The best stocks excel in many different areas, including these important factors:

  • Growth. Expanding businesses show healthy revenue growth. While past growth is no guarantee that revenue will keep rising, it's certainly a better sign than a stagnant top line.
  • Margins. Higher sales mean nothing if a company can't produce profits from them. Strong margins ensure that company can turn revenue into profit.
  • Balance sheet. At debt-laden companies, banks and bondholders compete with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.
  • Money-making opportunities. Return on equity helps measure how well a company is finding opportunities to turn its resources into profitable business endeavors.
  • Valuation. You can't afford to pay too much for even the best companies. By using normalized figures, you can see how a stock's simple earnings multiple fits into a longer-term context.
  • Dividends. For tangible proof of profits, a check to shareholders every three months can't be beat. Companies with solid dividends and strong commitments to increasing payouts treat shareholders well.

With those factors in mind, let's take a closer look at E*TRADE Financial.

Factor

What We Want to See

Actual

Pass or Fail?

Growth

Five-year annual revenue growth > 15%

(9.8%)

Fail

 

One-year revenue growth > 12%

4.5%

Fail

Margins

Gross margin > 35%

90.2%

Pass

 

Net margin > 15%

12%

Fail

Balance Sheet

Debt to equity < 50%

184%

Fail

 

Current ratio > 1.3

1.6

Pass

Opportunities

Return on equity > 15%

3.4%

Fail

Valuation

Normalized P/E < 20

26.53

Fail

Dividends

Current yield > 2%

0%

Fail

 

One-year dividend growth > 10%

0%

Fail

       
 

Total Score

 

2 out of 10

Source: S&P Capital IQ. NM = not meaningful due to negative earnings. Total score = number of passes.

Since we looked at E*TRADE Financial last year, the company has dropped another point, bringing its two-year total loss to two points. The stock has also languished, falling almost 10% in the past year.

E*TRADE has had a tough time in recent years, with a number of factors conspiring to hurt its results. On one hand, the market meltdown in 2008 shattered investor confidence, and despite a big rebound, many discount brokers haven't yet seen retail investors come back in full force. In its most recent quarter, E*TRADE reported lackluster commission and service-charge revenue.

But arguably the bigger hit facing E*TRADE and competitors Schwab (NYSE: SCHW  ) and TD Ameritrade (NYSE: AMTD  ) is the low-interest rate environment. Low rates hurt brokers by reducing the margins they earn on customers' brokerage account balances. With interest margin falling from 2.89% last year to 2.44% in the most recent quarter, E*TRADE has definitely felt the hurt, especially considering that Schwab somehow managed to increase its margin, even with near-zero short-term rates.

One big concern remains the impact that the election could have on E*TRADE and the industry. While many policymakers focus on full-service brokers Morgan Stanley (NYSE: MS  ) and the Merrill Lynch division of Bank of America (NYSE: BAC  ) , discount brokers will also inevitably be affected by regulatory changes. The real key, though, is stoking investor confidence in the financial markets to the point at which E*TRADE starts seeing customers come back.

For E*TRADE to improve, it needs to start building revenue back up and look for higher-margin lines of business. Without success on those fronts, E*TRADE will have a tough time becoming a perfect stock anytime soon.

Keep searching
No stock is a sure thing, but some stocks are a lot closer to perfection than others. By looking for the perfect stock, you'll go a long way toward improving your investing prowess and learning how to separate the best investments from the rest.

E*TRADE Financial is a big player in the discount brokerage world, but Bank of America has a much wider view of the entire financial industry. Read up on B of A's prospects by getting the Fool's premium report on Bank of America. Just click here and get your report today.

Click here to add E*TRADE Financial to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.

Fool contributor Dan Caplinger doesn't own shares of the companies mentioned. The Motley Fool owns shares of Bank of America. Motley Fool newsletter services have recommended buying shares of and writing puts on TD Ameritrade. We Fools may not 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. The Fool has a disclosure policy.


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