Bet On These Brokerage Companies!

Vladimir is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

As the market continues to rise, investors jump in. If you are reading this article, you are interested in investing, right? Your interest and the interest of millions of other people paves the way for brokerage stocks to perform better. They have had a tremendous year. TD Ameritrade (NYSE: AMTD) and E*TRADE Financial (NASDAQ: ETFC) are up 60% and 66% respectively, while Charles Schwab (NYSE: SCHW) is up 54%. Should you bet on the continuing interest in trading and investing?

Increased activity

TD Ameritrade reported that clients’ assets have grown to $524 billion, up 18% year-over-year. Average client trades per day increased 6% sequentially. Net new client assets grew 8%. Clients’ assets grew 17% at Charles Schwab, while E*TRADE enjoyed a 14% rise in clients' assets. Charles Schwab noticed that a modest rebound in client activity lifted trading revenue 7%.

What is causing this? First, it’s the market growth. As the market continues to make new highs, more people feel the need to profit from it. Market growth partly explains the growth in the clients’ assets. The next driver is the beginning of the shift from bonds to equities. The run for safety is mostly over and clients are willing to take risks. Due to the volatile nature of the market, equity trading involves more transactions, leading to healthy commission revenue.

Would this trend continue?

It takes time to regain confidence after such events as the recent crisis. The retail market is in the early stage of rebuilding this confidence. The shift from bonds to equities is likely to continue as people begin to prefer returns over safety. Next, the Federal Reserve would be ultimately unwinding its bond-buying program. This would lead to increased volatility in the market. The volatility brings more activity and leads to profits for brokers.

The development of trading platforms, as well as their availability across multiple platforms, would also contribute to the positive trend. Trading platforms are a lot more user-friendly than they were just five years ago. Everything is done to take the technical side off the investment process for the end user. The fact that clients can manage their money from tablets and smartphones, which they carry with themselves, would lead to increased confidence.

Which one should you choose?

Now that we’ve established that the macro trend is positive for brokerages, which one should you choose? These stocks have gone a long way up this year, pushing their valuations higher and higher. TD Ameritrade is trading at 20.52 forward P/E, and is the cheapest one according to this metric. Charles Schwab trades at 25.30 forward P/E, while E*TRADE trades at 20.64 forward P/E.

Charles Schwab is the biggest company. It theoretically means that it is more difficult for Charles Schwab to show the same growth rates as E*TRADE, which is the smallest of the three, because it starts from a big base. There is little surprise that Charles Schwab has gained less this year than its peers. In addition, Charles Schwab provides banking services, as well as ETF offerings.

E*TRADE declared that it is closing its market-making business and took a $142 million goodwill impairment as a result of this action. In my opinion, this makes the company more focused. The market was pleased with the announcement and the stock rose 8% on the day of the report.

TD Ameritrade has set a bunch of internal records this quarter. The company posted record net revenue of $725 million, as well as record market fee-based revenue of $65 million. It also achieved record mobile trades and record derivatives trades. Moody's has upgraded TD Ameritrade to "A3". If the company can continue such a momentum, the shares would ultimately appreciate.

Bottom line

The biggest risk is the pace at which these stocks have appreciated. The big picture looks good for the business. Charles Schwab is less focused and most expensive, so I would not choose this one. TD Ameritrade and E*TRADE look good. However, I would recommend waiting for a pullback, because it’s highly possible that the shares have gotten ahead of themselves.

Analysts’ mean target prices back this conclusion. They suggest 15% downside for Ameritrade, 10% downside for Charles Schwab, and 21% downside for E*TRADE. These targets are too much on the downside, but a significant pullback would make the brokers attractive.

With the American markets reaching new highs, investors and pundits alike are skeptical about future growth. They shouldn't be. Many global regions are still stuck in neutral, and their resurgence could result in windfall profits for select companies. A recent Motley Fool report, "3 Strong Buys for a Global Economic Recovery," outlines three companies that could take off when the global economy gains steam. Click here to read the full report!

Vladimir Zernov has no position in any stocks mentioned. The Motley Fool recommends TD Ameritrade. The Motley Fool owns shares of TD Ameritrade. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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