To start the issue at the bottom line, let's look at E*Trade's earnings per share over the last couple of years, and looking forward:
1997 $0.10 1998 $0.02 1999 -$0.23 2000E -$0.47 2001E -$0.15This once profitable business is now bleeding red ink. All right, I know the quick response to this. "Oh, they're just spending money to grow their business. Don't look at the bottom line, look at the top line, where sales have grown at a 115% compounded rate over the last three years." To that, I have to offer a big yawn.
There's a huge difference between spending money to buy a brand and investing money to build up a uniquely positioned business that has real competitive advantages. There's simply nothing unique about what E*Trade does, except spend more money on advertising than any of its rivals. Despite buying the Super Bowl half-time show, and promising to increase its marketing budget to $350 million this year, E*Trade doesn't offer any evidence that it has a particularly special brand. After all, can you remember which commercials are E*Trade's and which are Ameritrade's? If you can, you've been watching too much CNBC.
Where's the vaguest hint of a competitive advantage here? If you compare E*Trade's price per share for trading ($14.95) to any of the five brokers in our discount brokerage area, you'll see that E*Trade's prices don't beat any of these rivals. And of course there are dozens and dozens of other brokers out there beyond those five. Even worse, because of the extraordinarily high level of competition in this space, E*Trade has been dropping its prices, and will continue to have to do this to stay competitive. This explains why E*Trade's gross margins have dropped significantly over the last two years, and are expected to be in the neighborhood of 50% this year (according to an April 4 Prudential Securities report) after being around 59% in 1998.
In fact I'm tempted to sum up the whole argument against E*Trade in two words: American Express <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: AXP)") else Response.Write("(NYSE: AXP)") end if %>. Since American Express is now offering completely free trades -- the hydrogen bomb of the discount brokerage battle -- how exactly is E*Trade ultimately going to be able to compete? Does it have a better brand name than American Express? Does it have a bigger advertising budget? And if so, how long can it keep that up?
I'll back off that argument only to this degree. I see that there are some people on the discount brokerage message board who are awfully steamed about the service that the AmEx brokerage is currently providing, and if E*Trade has an advantage in customer service, I won't argue that that does translate into something around which a business can be built. While E*Trade recently was ranked sixth out of the seven most popular brokerages for TheStreet.com's readers, E*Trade fares much better according to Gomez.com, actually ranking first of all online brokers at that site.
So E*Trade does have some customer satisfaction to rely upon in keeping the accounts that it has, but E*Trade isn't getting new accounts by word of mouth (one sign of a good brand); it's simply spending a lot to acquire new accounts. Over the winter, E*Trade spent around $400 per new account opened. Unless those accounts are extraordinarily active traders, it will take a long time for E*Trade to recoup that expenditure as the average account that E*Trade acquires is quite small.
E*Trade's average account is $20,000 -- half that of Ameritrade and one-fifth of Schwab's average. This is particularly troubling combined with E*Trade's skyrocketing acquisition costs. Yankee Group estimates the average online brokerage account has between $25,000 - $37,000 while the average U.S. investor (online or off) has an average $100,000 in financial assets. So the type of customer that E*Trade is attracting is exactly the wrong kind.
Consider what happened when we had that momentary blip in the market last week. E*Trade reported that its margin calls had increased two or three fold over normal volumes, whereas other more established brokers were not reporting particularly high margin calls. So, E*Trade is acquiring too many of the kind of accounts that would be completely wiped out by any real bear market -- even if it only lasts about an hour and a half.
I'm not that old, but I've heard rumors that there are bear markets that actually last longer than lunchtime. If so, you'd better consider just how stable E*Trade's customer base is, and whether a business model built around such risky customers can survive rougher times. If the whole growth strategy is based on signing up day-traders and margin accounts, I'm hard pressed to think of too many companies that I'd consider less attractive.
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