Banc of America Securities initiated coverage of six brokers Friday with buy ratings on two companies even as some in the sector struggle to cut costs while market volatility and a weakening economy prompt a slowdown in retail investing.
TD Waterhouse Group, a broker mostly owned by Toronto-Dominion Bank, and Knight Trading Group each got buy ratings. Four other companies CSFBdirect, Ameritrade Holding Corp., E-Trade Group, and Charles Schwab Corp. were rated market perform. Analyst Robert Sobhani, who joined the Bank of America Corp. unit in October from Salomon Smith Barney, said that he is generally bullish on the online brokerage sectors long-term outlook.
And the shift in Fed policy should bode well for the sector, he wrote in his research report. However, consumer confidence must regain momentum to boost online brokerage stocks, since people will not be investing in the equity market if they are cutting back on their general spending, Mr. Sobhani said.
We need a broad rally to overcome the sluggish momentum among retail customers, he said. But he added in his report, Given Nasdaqs strength in January, we have an upward bias to our numbers.
Though the era of hypergrowth is over for the group, earnings should grow 25% or more during the next three to five years and industry accounts could double in the next three years, to 39 million. That could potentially bring over $1 trillion more of customer assets to online providers, he wrote.
And there is still room for growth in online investing since no more than 25% of U.S. equity owners have online accounts, he observed.
However, discount brokers are going to have to build their advisory capabilities to gain further ground, Mr. Sobhani said.
For example, TD Waterhouse benefits from the online trend but has the brick-and-mortar infrastructure to offset slower times, he said. And the company is trading at a relatively low multiple of about 27 times earnings; Schwab is fully valued and trades at more than 50 times earnings, he said. TD Waterhouse stock closed Friday at $15.26 a share, up 21 cents, or 1.4%, and well below Mr. Sobhanis target price of $22.
We believe TD Waterhouse will increasingly be viewed as the safest way to play the growth of the online brokerage sector as its profit discipline, branch infrastructure, and international diversification help separate it from the pack, Mr. Sobhani wrote.
Schwab gets a lot of premium for repeatedly reinventing itself, Mr. Sobhani said, referring to the companys move into financial advisory, retail brokerage, and online brokerage. But with its latest attempts to attract high-net-worth clients, Schwab enters an already crowded field, he said, which could crimp its multiple rather than providing more upside. And the company, which saw profits decline for the first time in three years last quarter, has been trying to cut costs without layoffs.
However, Schwab and TD Waterhouse should benefit from growth overseas, where both have made inroads. Last week the two companies announced that they would team up in Britain to buy Aitken Campbell, a firm that makes markets in British stocks.
Meanwhile, the American Banker index of 50 bank stocks fell 0.27% Friday, and its index of 225 stocks was down 0.68%.