E*Trade Financial (NYSE:ET) reported third-quarter earnings after the close on Monday of $0.21 per share, easily beating the consensus estimate of $0.18. Revenues came in at $337 million compared with an estimate of $360 million.
DARTs did show a serious decline. What are DARTs, you ask? They are "daily average revenue trades," a key metric for discount brokers. For the quarter, DARTs came in at 97,400, down 24% from the second quarter and down 27% from the same period last year. A downtrend in DARTs is not unique these days; industry leader Charles Schwab (NYSE:SCH) has seen declines in its DART count as well. All summer long the cable market news bigwigs have bemoaned the light volume, so it should be no surprise that trading activity is down.
One very positive element of the report was that E*Trade increased its earnings guidance. The previous range for 2004 had been $0.87-$0.97, but management narrowed that to $0.92-$0.97. While this is not kick-up-your-heels news, investors will be glad to take anything positive in a sector that has been dominated by bad news for years. The company is very optimistic that the worst may be over, citing that DARTs for October, so far, are running at 114,000.
OK, but what should investors do with these brokerage stocks? Over the last several months the discount brokers have all gone down, though E*Trade has held up the best. In an effort to look forward, I see a couple of different problems the stocks could face.
First is that a lot of analysts think that commissions will go to zero. While that may or may not be true, there has been downward pressure on commissions for several years, and the prospect of yet lower commissions is still front and center.
The other big wind of change is on the legal front. Or, I should say, the threat of legal action. Eliot Spitzer has gone after the wire house brokers, the mutual funds, and now the insurance companies, so who's next? Are there similar issues with the discount firms? I don't know. But I wouldn't be surprised if something came up regarding order handling and execution. It seems only logical that if Spitzer's office has investigated all these other areas of financial service, why not the discounters? Of course, I'm just speculating and I could be very wrong about that.
To me, then, it seems like a tough time to make a big bet on financials, despite E*Trade's optimism for its fiscal year.
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Fool contributor Roger Nusbaum is an investment manager and wildland firefighter in Prescott, Ariz. At press time neither he nor his clients owned any stocks mentioned.
