The Truth About E*Trade

E*Trade Group, Inc. reported quarterly results this week that far exceeded Wall Street estimates in an atmosphere where revenues — not profits — still rule.

Analysts seemed ecstatic with the number two Internet broker, in spite of what should have been one sobering detail: E*Trade lost $23.2 million (US$), or 8 cents a share, in its second fiscal quarter ended March 31st. The company showed a profit of $8.5 million, or 3 cents per share, just one year ago.

Nevertheless, investors seemed to approve the results. E* Trade’s stock shot up 13/16 to 25 1/4 by mid-afternoon Wednesday, even though the Nasdaq had fallen 177 points by then.

It appears that Wall Street is mesmerized by the fact that E*Trade’s net revenues rose 152 percent to $407 million.

Also, E*Trade added a positive spin to its numbers, telling analysts that the company actually booked a small profit of $1.3 million, or nil per share, if one-time gains and acquisition charges are excluded from its quarterly numbers.

Brokerage Industry Strength Underestimated

According to market research firm First Call/Thomson Financial, E*Trade was able to beat Wall Street’s quarterly forecast because analysts have been consistently underestimating the brokerage industry’s strength. In fact, outperforming unrealistic expectations has put the gloss on E*Trade’s results for the past eight quarters.

Unabated infatuation with the stock market — a concept as American as apple pie — has led investors to funnel more than one million stock trades a day through the Internet in the first quarter, up almost 50 percent from the fourth quarter. Share volumes have also reached record levels at U.S. exchanges.

E*Trade, which ranks second only to Charles Schwab Corp. among U.S. online brokers, has been in the center of the action. The firm processed a record 229,000 stock trades per day in the January to March quarter, up from 70,000 daily a year ago and its previous record of 133,000.

The Menlo Park, California-based company also said it signed up a record 603,000 new customers in the second quarter, bringing its total to 2.6 million.

All the Wrong Moves

While all of these figures sound impressive, E*Trade is not a profitable company and still has not delivered earnings to its investors — despite having a market capitalization of $7 billion. In fact, stockholders watched helplessly as E*Trade’s price per share fell from its 52-week high of 72 1/4 to its current perch in the mid-twenties.

While the company bought Internet-based bank Telebank to expand its financial services, it has yet to form a strong alliance with a brick-and-mortar financial institution. Such a relationship could allow E*Trade to offer more value-added services to its customers, including individual stock analysis.

Instead, E*Trade is buying Card Capture Services, Inc., a private operator of about 8,000 ATM machines. In my opinion, this addition will not be enough to boost its offline presence — or its competitive position against such brick-and-mortar financial giants as American Express, which continues to aggressively expand its cyber presence.

Blissful Ignorance

Considering the growing likelihood that a shakeout of profit-barren dot-coms could reach earthquake intensity, it is hard to understand why Wall Street continues to be dazzled by E*Trade’s soaring revenues. The Street seems blind to the reality that E*Trade is based upon the same flawed model.