Despite Pop, E*Trade Is Sector's Valuation Runt

Riding a wave of buying in the financial sector, online brokerages and banks have surged over the past two sessions, though some more than others. Despite a lack of news, E*Trade(ET Quote) is up about 18% since Friday, whereas peers Ameritrade(AMTD Quote) and Charles Schwab(SCH Quote) rose 10% and 9%, respectively.

E*Trade's divergence from the pack highlights how differently investors and analysts value the three companies. A race to diversify and continuing consolidation in the sector have created wide gaps between their multiples. Whereas E*Trade currently trades at 21 times estimated 2002 earnings, Ameritrade trades at 29 times 2002 estimates and Charles Schwab trades at 33 times estimates.

Analysts said the pop in E*Trade shares reflects the fact that they've fallen further than other sector stocks over the past two months on rumors the company is hunting for more acquisitions. In an effort to transform itself into a full financial services company, E*Trade has bought more than a dozen companies in the past several years, and is thought to have a $400 million treasure chest for new acquisitions.

War Chest

But E*Trade's appetite for acquisitions adds integration risk, and there is some skepticism over whether the company will be able to cobble together a one-stop financial services shop. The company's increasing dependence on banking services also lowers its potential growth rate.

"Few if any companies have been successful at becoming full financial services providers," says Glenn Schorr, Deutsche Banc Alex. Brown analyst. "E*Trade has had some success with that, but they need a whole lot more to sustain a multiple of 20 to 30 times earnings," he said. If it becomes too dependent on banking, the company's valuation could fall to around 12, the kind of multiple usually sported by regional banks, said Schorr.

Mainly through acquisitions and partnerships, E*Trade now sells mortgages and other loans, and offers portfolio advice. The core online business has also expanded: The company bought Web Street Securities last year, adding 34,000 accounts, and picked up the retail brokerage of Wit Capital the year before.

Trust Premium

While Charles Schwab has probably diversified even more aggressively than E*Trade, it has made fewer acquisitions to do so and is focusing its efforts on the lucrative, high-growth areas of asset management and investment advice.

Meanwhile, the company has always traded at a premium to the rest of the group because it is a larger company with a longer history, a wider distribution network and a strong management team that investors seem to trust, said Shaw Lively, an analyst with IDC eFinance.

Ameritrade remains centered on its core retail brokerage operation, which tends to offer slower growth than asset management, but it is adding new accounts faster than Schwab or E*Trade and it gets a premium because it is an acquisition target, said J.P. Morgan Chase's Greg Smith.