E TRADE Financial Corporation Is a Discount Brokerage Trading at a Big Discount

As the only discount brokerage with legacy subprime mortgage assets on its balance sheet, E*TRADE could have some serious upside potential as the core business grows

May 31, 2014 at 7:00AM

E*TRADE (NASDAQ:ETFC) is one of the world's largest discount brokerages, and is a completely different type of investment than its peers like TD Ameritrade (NASDAQ:AMTD) and Charles Schwab (NYSE:SCHW).

Because of its differences, it may offer the best long-term growth potential of the three. Now that shares are more than 20% off from their March peak, now may be a great time to give E*TRADE another look.

What makes E*TRADE so different?
Basically, what makes E*TRADE so much different than its peers is its banking activities, in addition to its brokerage. Specifically, E*TRADE offers checking and savings accounts, and was involved in the mortgage origination business before the financial crisis hit.

Of course, times got tough for anyone involved with subprime mortgages and E*TRADE was no exception, with hefty exposure to toxic loans. The company needed a $2.5 billion cash infusion and completed a secondary stock offering in order to make it through the crisis years.

Since then, E*TRADE has taken steps to focus on its core brokerage business, and they have done a great job with it.

A great product
Not only is E*TRADE perhaps the best known brokerage among the American public thanks to its "baby" commercials, but the company offers a level of services and investing possibilities its competitors simply can't match.

For example, E*TRADE's global trading account allows investors to convert money in their accounts to local currencies and place live trades on six foreign stock exchanges (Canada, Germany, U.K., France, Hong Kong, and Japan). Additionally, investors have access to stocks and ADRs listed on 60 international exchanges in 35 foreign countries.

Additionally, E*TRADE offers "complete" accounts that come with a Visa debit card linked to the account, essentially combining the practicality of a checking account with a brokerage account. The company allows customers to have instant access to brokerage deposits from a checking account, while most competitors make wait until the next business day to make deposits available.

Great progress, but not quite there yet
During the most recent quarter, E*TRADE's net income nearly tripled from the same quarter last year. The company's asset portfolio has improved tremendously. In fact, E*TRADE reported that it set aside just $4 million to cover loan losses for the quarter, less than one-tenth of the $43 million provision in the first quarter of 2013.

E*TRADE also sold about $800 million in troubled loans during the quarter, which reduces its current portfolio of loans to $7.4 billion. So, there is still some work to do in regards to winding down bad assets, but tremendous progress has been made.

Additionally, the company's brokerage business is booming, and daily trading volume is its highest in five years. The number of accounts grew to 3.1 million, a 5% increase over the past year. Also good for E*TRADE's revenue, customers' margin balances total $7.3 million, a level not seen since 2008.

The possibilities outweigh the risks
Analysts have become rather bullish on E*Trade, expecting earnings to rise by nearly 150% over the next three years. Trading volumes are up, new accounts are being opened, and the bad assets are slowly but surely going away. With such a low loan-loss provision relative to the size of the portfolio, we can infer that the loans' overall quality has risen tremendously.

Trading for less than 19 times this year's expected earnings, E*TRADE looks like a bargain at current levels, and will become more and more profitable as the losses from bad assets continue to taper off.

Is this a more revolutionary bank than E*TRADE?
There's a brand-new company that's revolutionizing banking, and is poised to kill the hated traditional brick-and-mortar banks. That's bad for them, but great for investors. And amazingly, despite its rapid growth, this company is still flying under the radar of Wall Street. To learn about about this company, click here to access our new special free report.

Matthew Frankel has no position in any stocks mentioned. The Motley Fool recommends TD Ameritrade. The Motley Fool 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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