Has E*TRADE Financial Become the Perfect Stock?

Finding companies that have all the right stuff can produce winners.

Dan Caplinger
Dan Caplinger
Sep 26, 2012 at 10:59AM
Financials

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 (NASDAQ: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.


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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.