Online Brokers Glide Onto the Dance Floor

Wallflowers no more.

Online brokerage stocks, which sat out most of the Nasdaq's recent rally, stopped hugging the sidelines Wednesday after industry giant Charles Schwab (SCH) estimated that fourth-quarter earnings would soar beyond analysts' wildest dreams.

With Schwab back on investors' minds -- the stock gained 7 11/16, or 22%, to 42 -- the other online brokerages suddenly found their dance cards full as well. E*Trade(EGRP) and Ameritrade (AMTD), as well as laggards like National Discount Brokers (NDB) and TD Waterhouse(TWE), moved by double digits. DLJdirect(DIR) gained 9%.

The reason, according to some money managers, is that these brokerages have been largely oversold during the past month as names such as Qualcomm (QCOM) or Ariba (ARBA) attracted investors who had been so active in driving these tech-oriented brokerage stocks earlier this year.

"Money has been diverted from the Dow stocks and the financials. The whole area has been ignored for the last two months. We've seen the online brokers -- which truly are going to have one of the best quarters they are going to have -- be oversold," says Titan Financial Services' portfolio manager Gilbert Giordano. (Giordano is long all the online brokerage stocks mentioned.)

But now that Schwab and the other online brokers are back in the mix, can it last? John Dale, portfolio manager for Peregrine Capital Markets' growth equity funds, says he's seen this type of reversal 20 times before. For all anyone knows, today's rally might just have the staying power of Britney Spears' rare genius.

But with a slew of online brokerage and brokerage earnings due out in only a few weeks, that could be a driving force for a sustained rally. Scott Appleby, an analyst at Robertson Stephens, a unit of FleetBoston (FBF), says it will last. "I think it's more than sustainable. These stocks have been vast underperformers and today is a proxy for what's going to happen," Appleby says. That's because at companies such as Ameritrade and E*Trade where revenue is even more commission-based, the banner quarter will affect the bottom line even more. (Robbie Stephens has done underwriting for E*Trade in the last three years, but not for Ameritrade or Schwab.)

And as Chase H&Q analyst Greg Smith wrote in a research note today, even if trading drops off next month, there will be new money coming into the market that can only build on Schwab's asset base of more than $700 billion. The firm hasn't done any underwriting for Schwab but has a research distribution agreement.

Schwab's news surprised investors who were expecting a quiet pre-year 2000 sort of trading day. The firm, a spokesman says, was less interested in an ambush than it was in satisfying its disclosure obligations, an issue that has become a crusade for the Securities and Exchange Commission.

Schwab said Wednesday that it expects fourth-quarter earnings to come in at 19 cents to 20 cents per share compared with 12 cents per share in the year-ago quarter. Analysts polled by First Call/Thomson Financial predicted earnings of 17 cents per share. Trading activity -- which translates to more commission revenue -- was higher in December than even November, rising to 236,000 a day.

That would have been hard to believe before Wednesday's lovefest. Schwab's stock was down 11% in December after having hit a 52-week high of 75 1/4 on April 13. And it's not the only online brokerage stock that has suffered; Ameritrade is off 60% from its high of 57 3/4 that same day.

It's not that there hasn't been the kind of good news that has spurred these stocks to new highs during the past year. Nasdaq volumes have been at record levels, and Knight-Trimark (NITE), a Nasdaq market maker and benchmark for online brokerages, has been racing ahead.

Still, the online brokerage stocks hung back. And there hasn't been any of the seemingly bad news that has punished the online brokers in the past, as the declines in trading volumes did during July and August. The only possible explanation are concerns that newcomers to the online business -- namely traditional brokerage Merrill Lynch (MER) -- will gain market share.

It's an old story for Schwab, says Dale, who's owned the stock for more than 10 years. "We've seen momentum investors going from dumping on them to paying attention to them again."

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