Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...
TD Ameritrade (AMTD) hasn't been the best performing online broker stock this year. (That would be E*TRADE Financial (ETFC).) It isn't the cheapest online broker stock, either. (Again, that's probably E*TRADE.) And yet, it's TD Ameritrade's stock that's getting the nod from Swiss investment banker UBS today, as the analyst places its bets on the best brokerage stock to buy.
Here's what you need to know.
UBS rolls the dice, and finds TD Ameritrade stock comes up a winner. Image source: Getty Images.
Upgrading TD Ameritrade
When TD Ameritrade last reported earnings (about a month ago), the stock beat expectations, reporting a pro forma profit of $0.92 per share where Wall Street had been looking for only $0.88. Revenue came in slightly ahead of estimates at $1.4 billion, and management laid out guidance for total fiscal 2019 revenue of $5.75 billion.
That number was actually below analyst predictions for the year. Fortunately, UBS isn't basing its decision to upgrade TD Ameritrade stock (to "buy," with a $60 price target) on last quarter's performance -- or even on what most analysts believe the company will do in 2019, either.
The stress test
Instead, UBS says its optimism about TD Ameritrade arises from a combination of two factors: First, the fact that the stock's multiple to earnings is now 34% below that of the Financial Select Sector SPDR ETF as a whole -- and therefore cheaper than the multiples for either Charles Schwab (SCHW 0.01%), which sells for a 20% discount to the XLF, or E*TRADE, which costs 18% less.
The second factor boosting UBS' confidence in TD Ameritrade stock, as explained today in a note on StreetInsider.com, is the fact that UBS has run its own stress test on the big brokerage stocks. Based on the results of that stress test, UBS concludes that while brokers in general are likely to weather a bear market pretty well, TD Ameritrade currently carries the least amount of downside risk in the event that last month's tech stock rout turns into a long-term, broader bear market in stocks.
UBS goes on to explain that "we found AMTD earnings down 13%, ETFC down 15% and SCHW down 18% in our bear case scenario." While those aren't terrific results, they nonetheless tell UBS that there's really "not...much difference in earnings at risk from a market downturn."
Regarding TD Ameritrade in particular, UBS found that its net interest income, or NII, could take a greater hit because it does "proportionally more margin lending" than its peers. Furthermore, Ameritrade would suffer from lower daily average revenue trades ("DARTS" -- or more simply, less trading and for fewer shares of cheaper stock) as investors hunker down in a bear market. On the other hand, UBS sees it suffering less of a decline in its asset management (AM) than its rivals. This last factor, in UBS' view, "moderated the downside" that TD Ameritrade might suffer in the event of a big bear market.
And what about the upside?
As for the upside of buying TD Ameritrade, well, UBS is saying that in its estimation, TD Ameritrade stock should be worth about $60 a share one year from now. With the stock currently trading for just $52 and change today, that works out to about 15% upside. Plus a healthy 2.3% dividend yield on top, that works out to better than a 17% promised profit for investors who follow UBS' advice today.
How likely is that to happen? Well, consider that with $1.5 billion in trailing earnings, TD Ameritrade shares currently sell for almost precisely 20 times earnings today. That's compared to 21 times earnings for Schwab, and a bit more than 15 times earnings for E*TRADE -- but here's the thing:
The potential for a brief bear market notwithstanding, according to estimates compiled by S&P Global Market Intelligence, the most likely result expected from analysts who follow these brokerage stocks is that over the next five years, TD Ameritrade will grow earnings at 23%. That's compared to only a 20% projected growth rate for E*TRADE, and 19% for Schwab.
The upshot for investors
Now admittedly, when I look at numbers like these, I'm far more inclined to place a bet on E*TRADE at 15 times earnings and a 20% growth rate than on Ameritrade -- even at 20 times earnings and a faster 23% growth rate. Although both companies seem to be holding up well against the (exaggerated, in my view) threat from free stock trading offerings at companies ranging from Robinhood to Chase, and growing sales and earnings nicely, E*TRADE simply looks like the better value to me. (On the other hand, I agree with UBS' apparent assessment that Schwab is too pricey relative to the competition: UBS downgraded Schwab to "neutral" today.) Objectively speaking, though, it's hard to argue with UBS' conclusion that Ameritrade, too, is cheap enough to buy.
And UBS is therefore right to recommend it.
