Caroline Humer
Online brokers may have been wobbled by the spring stock market tremors, but they seem to have regained their footing despite trading shortfalls that reduced customer activity by more than 25% last quarter.
Now brokerage executives and analysts will be keeping a cautious watch on the next three months -- a time of year when many investors typically pay more attention to sunscreen than their stock screens. That "seasonality" was on the tip of everyone's tongues Wednesday during the conference calls that followed online broker E*Trade's (EGRP Quote - Cramer on EGRP - Stock Picks) and Nasdaq market maker Knight Trading's (NITE Quote - Cramer on NITE - Stock Picks) earnings reports. That means investors who haven't done so already should prepare for another several months of meandering online-broker stock prices. The trading nirvana of the first three months of this year, in which the skyrocketing Nasdaq Composite Index and the Dow Jones Industrial Average drew massive numbers of new investors to the equity markets, evaporated in the early second-quarter carnage and isn't likely to reappear this year. "July's been OK. It is an earnings month and it's been fairly strong. It's been decent, but I don't think anyone is expecting much from the quarter," says Greg Smith, an analyst at Chase H&Q. His firm has underwritten for E*Trade but not for Knight. That means that trading volumes, which fell on average 25% during the second quarter, will be flat to lower during the third quarter, Smith says. This year's shabby volume hasn't helped the online broker stocks. The sentiment now is that absent a dramatic pickup in volume or major industry consolidation, there isn't much impetus for a big move up. Wednesday's market reaction is a good example. E*Trade said it broke even on an operating basis, compared with a loss of 8 cents in the quarter one year ago and above the 1-cent loss that analysts had expected. E*Trade also said average daily trades had fallen 26% to 169,000. Its stock started higher Wednesday, but at the close was down about 1%. Knight, a Nasdaq market maker with the vast majority of its business tied to orders it executes for the online brokers, also reported better-than-expected earnings Wednesday of 53 cents a share, compared with the projected 51 cents a share. That profit was unchanged from a year ago and down from the $1.08 that Knight booked last quarter. On the back of several days of gains in the stock that analysts attributed to some high whisper numbers, Knight lost more than 4% Wednesday. Its trades per day dropped 24% to 528,340 from nearly 700,000 in the first quarter. Matthew Vetto, an analyst at Salomon Smith Barney, has no hopes of seeing the first quarter repeat itself. "I think most people are looking at that as an anomaly not likely to repeat itself in its current form," he says. Indeed, if this quarter showed one thing, it's that the large online brokers don't need the kind of growth they relied on as smaller players to produce solid earnings. E*Trade's revenue dropped 19% and the company still came out in the black by reining in costs. Charles Schwab (SCH Quote - Cramer on SCH - Stock Picks) pulled in new assets at twice the pace of Merrill Lynch (MER Quote - Cramer on MER - Stock Picks) as its customer assets neared the $1 trillion mark. And Knight's diversification into options and international business started to contribute to its bottom line. Only the much smaller DLJdirect (DIR Quote - Cramer on DIR - Stock Picks), a unit of Donaldson Lufkin & Jenrette (DLJ Quote - Cramer on DLJ - Stock Picks), suffered from low trading numbers, posting a loss of 6 cents a share. With those kinds of results, online brokers are hoping the summer will leave their clients burnt more from the sun than from the market.
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