Shares in Internet brokers show signs of life after a painful spring and summer stumble

Monday, September 18th 2000, 12:00 am
By: News On 6

By Bill Deener / The Dallas Morning News

Stock trading and the Internet – it seems the perfect marriage.

Financial data is easily converted into bits and bytes, and cyber brokers don't have the hassle of shipping products to customers. But earlier this year, shares in the companies that provide online trading fizzled. And investors quickly saw their virtual riches turn into real losses as most of these stocks dropped 50 percent and more.

Investors in online brokerage companies had turned against them, just as they had turned against the pipe dreams peddled by the retailers.

And yet, the online brokerage industry is made of sterner stuff – namely, real earnings – and a healthy rebound is already in the works, analysts said.

"The trends for online trading are tremendously strong," said William Wong, an online brokerage analyst for Josephthal & Co. in New York. "Most all of the large online brokers are on a clear path to profitability."

The spring and summer stumble notwithstanding, the explosion in the popularity of online trading has been phenomenal.

Not much more than a cyber-curiosity three years ago, online trading now accounts for about 35 percent of all retail stock trades, industry experts said.

Firms such as Ameritrade, E*Trade, Schwab and Fidelity continue to sign up online customers by the millions.

Ameritrade Holding Corp. of Omaha, Neb., one of the fastest growing online brokers, increased the number of online accounts over the last year by 130 percent to just over 1 million.

"We added on more accounts in the first nine months of this fiscal year than we have in the last 25 years," said Pete Ricketts, vice president of strategy for Ameritrade.

The overall number of online customers has soared from a few thousand in 1996, to 5 million by 1999 and to more than 9 million today, according to Gomez Advisors, an industry research firm in Lincoln, Mass.

And as anyone who watches CNBC for more than five minutes already knows, the number of firms offering these services has proliferated from fewer than 30 in 1997 to 180 today, according to Gomez Advisors.

"We estimate that there are over 15 million more customers of the traditional brokers who are just waiting in the wings to move online," said Matt Carrick, research analyst at Gomez.

But the spring debacle in online brokerage shares was a stunning setback for this newfangled industry. And market experts are hoping investor enthusiasm is more subdued the second time around.

Irrational expectations gripped the industry in late 1999 and early 2000, and share prices soared skyward. Warnings to investors about overly inflated stock prices provided as much of a deterrent to the speculation as waving a biscuit at a mad dog. After the stocks hit bottom in late March and the technology-laden Nasdaq composite index dropped 37 percent, the rout was on in the online brokerage sector as well.

Shares of Charles Schwab Corp., which had hit $43.33 in March, had fallen to $23.45 by May. The stock of E*Trade topped $32.63 in March and then fell back to $13.94 in May.

And since most online traders prefer to trade Nasdaq stocks, the downturn in the Nasdaq drastically reduced the transaction volume of online brokers.

The number of trades recorded by the top five online brokers, which was up 40 percent in the first quarter, dropped by 20 percent in the second quarter, according to a report by Putnam, Lovell Securities Inc., a New York investment research firm.

For example, Datek Online, based in Iselin, N.J., was averaging 121,261 trades a day in the first quarter, but that number dropped to just above 100,000 by the end of the second quarter in June, the company said. This was indicative of much of the industry.

"After the spring correction, people just didn't want to trade as much," said Rich Repetto, an online analyst at Putnam, Lovell. "That hurt the online brokers."

Trading volume in the third quarter, which won't be over until Sept. 30, will probably be down an estimated 5 percent to 10 percent from the second quarter, but volumes are starting to rebound, analysts said.

"Some people thought the volume slowdown we saw in the second quarter would be permanent, but it's not," said Mr. Wong of Josephthal & Co. "The trend is up, and now investors are starting to buy shares ahead of the expected uptick."

Since August, shares of E*Trade have risen from about $14 to just above $19, while Ameritrade shares have risen from about $12 to more than $20.

And the story is much the same for most of the online brokerage firms.

In addition to the anticipated increase in transaction volume, which obviously will boost revenue and profits, several other positive factors are now in play, analysts said.

At the top of the list is the potential for consolidation. And with 180 companies, there's plenty of potential.

For much of the last year, the largest online brokers have been focused on getting their computer systems up and running and handling the customers they already have. But soon, they will start picking each other off, said Mr. Carrick of Gomez Advisors.

"Everyone has been asking that question of when will the consolidation start," said Datek spokesman Mike Dunn. "It's hard to predict, but it's coming."

Secondly, advertising expenditures are becoming a smaller percentage of revenue, Mr. Wong said.

E*Trade spent a whopping 47 percent of its revenue in 1999 on advertising, he said, but that percentage declined to 39.7 percent this year, and will be an estimated 29.2 percent in 2001.

Similarly, Ameritrade's advertising percentage will decline from 34 percent this year to 25.6 percent in 2001.

Russell Keene, an online brokerage analyst at Keefe, Bruyette & Woods, Inc., said these companies are basically keeping their advertising and marketing budgets stable, while their revenue increases.

"They are getting some leverage now with their advertising, and the same thing applies to their technology," said Mr. Keene. "They are spending less on technology but the revenue base is still growing."And finally, a growing number of online brokers, such as T.D. Waterhouse, Fidelity and Schwab, are adding all kinds of financial products to increase the size of their customer asset base. That is, the amount of money held in all of their customers' accounts.

Many online brokers now offer online banking, credit cards, mutual funds, financial planning tools and all manner of advice and commentary.

"In the future, they won't be able to get by just offering cheap stock commissions," said Mr. Carrick of Gomez.

"The next wave of customers that will come online want financial planning tools and they want one-stop shopping for all their financial services."