My colleague Rick Munarriz puts out an annual feature of interesting companies trading under $10. I like it. Since American businesses tend to want their shares priced between $10 and $100, Rick focuses on stocks priced under 10 bones that are turnaround candidates.

Otherwise, there's no particular magic to the $10 number, nor should "cheap" shares mean very much -- you get the same thing buying a single $910 share of Washington Post Co. (NYSE:WPO) as you would 100 shares if the company did a 100-for-1 split. It's the same exact thing -- and for some brokerages that charge on a per-share basis, it's actually a bit more expensive to trade more shares. (For more on this, see my recent article on the pointless stock split at Rocky Mountain Chocolate Factory (NASDAQ:RMCF).)

At any rate, one of the companies Rick mentioned was TradeStation (NASDAQ:TRAD), presently priced at about $8.20 per share. Naturally, since this is a strictly technical-analysis shop that markets itself to hyperactive traders, its business focus won't exactly get the "Good Housekeeping" seal from The Motley Fool. But, heck, you can invest in lots of stuff that you don't use. Some of my favorite investment ideas are mutual fund management companies.

TradeStation, however, is a wildly valued company with real pricing pressure and a flawed business model. I'd attribute its recent growth to one thing, and one thing only: A rapid return of speculative excess. It won't last.

The company offers an Internet-based brokerage for what it describes as institutional, professional, and serious active individual traders. It's had plenty of success growing its accounts this year -- up 58% over 2002 at 12,000 accounts, which means that it added about 1,000 accounts in the fourth quarter. This is an account uptake rate many times lower than low-cost rivals at Ameritrade (NASDAQ:AMTD).

Each account averages 588 trades, $3,800 in revenue, and $119,000 in asset base. (That's a friction cost of 3.1%, a ridiculously high percentage of assets. We rail on mutual funds with 1% fees. Yick.) TradeStation claims that there's an addressable market of 500,000 highly active traders or day traders, a number that strikes me as wildly high. Let's also not forget that -- looking at the trajectory of TradeStation's account additions over the last year -- we have reentered a period where the markets have become manic. It's the perfect environment for companies addressing the most speculative participants. Should we expect such an environment to continue? At a present valuation of five times revenues, and 30 times earnings and cash flows, TradeStation investors certainly do.

The company has also sought to grow its institutional business for years, with limited success. But here's where I think that their model is completely flawed. TradeStation positions itself as a backtesting/charting service. In the institutional area, this is a service that is widely available. Management says its service is superior. Well, maybe, but how many institutions are out there that strictly define their investing methodology as being based on technical analysis? Not that many, which means that TradeStation doesn't offer that much of value to most institutions -- no fundamental research, no execution advantage, no real cost advantage.

It's a sign that things are not as great as they would seem that the company recently lowered its trading commissions on the first 500 shares of an order from 1.2 cents down to a penny per share. This may not seem like a big deal, but look at the revenues per customer once again -- break it down by number of trades, and you can determine the average trade for 2003 and determine that the gross revenue per average trade was $6.46, a little higher than 500 shares. So for the vast majority of the average shares traded, the company just lopped off more than 16% of its revenue per trade.

Using the same approximation, I come up with revenue per trade at $5.38 this year, holding all other factors constant. You can trade up to 5,000 shares for $5 at Brown & Co. and avoid the monthly recurring $99 fee for TradeStation's platform. No wonder TradeStation is hungry for institutional customers -- the bigger trade sizes would make an enormous difference. Ditto on why the company is preparing to offer foreign exchange and options. Unless it can dramatically increase both number and size of accounts, it won't make much difference.

There may be a real reason active traders like TradeStation, but that doesn't necessarily translate into it being a good investment at present valuation -- there are just too many questions on sustainability.

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