Charles Schwab Corp (SCHW), TD Ameritrade Holding Corp. (AMTD): Sizing Up the Discount Brokers

The discount stockbrokers, led by Charles Schwab Corp (NYSE:SCHW), TD Ameritrade Holding Corp. (NYSE:AMTD), and E TRADE Financial Corporation (NASDAQ:ETFC), were some of the go-go stocks of the late 1990s, but much of their momentum has fizzled out over the past decade and a half. The industry was one of the early winners of mass internet adoption, as individual investors could trade at the click of a button. However, the tech stock meltdown of 2000 took some of the daytraders down with it, leading to consolidation among the discount brokerage industry. So, which firms are primed for success?

Schwab was a big beneficiary of commission deregulation in the 1970s, as the firm used heavy advertising and cheap commissions to build a leading customer base. The company was also at the forefront of product innovation with its OneSource mutual fund marketplace, which allowed customers to buy and sell a wide inventory of mutual funds without transaction costs. With nearly $2 trillion in client assets under custody, Charles Schwab Corp (NYSE:SCHW) sets the industry curve in terms of pricing.

In FY2012, Schwab reported modest gains in its financial results, with increases in revenues and operating income of 4.1% and 4.2%, respectively, versus the prior year. While fees from assets under management grew 6%, helped by some complementary acquisitions, trading revenues declined as customers’ daily trading volume fell 7%. In addition, the company continued to suffer from low yields on its float, a negative consequence of the Federal Reserve’s artificial interest rate policy.

Looking ahead, Schwab continues to transform into a traditional, full-service investment firm, as it tries to offset its retail customers’ lackluster trading activity. The company has pursued growth in its fund management segment through acquisitions, including the purchases of Windward Investment Management in 2010 and ThomasPartners in 2012. Of greater significance, though, was Charles Schwab Corp (NYSE:SCHW)’s creation of a bank in 2003, which has allowed the company to move into the national mortgage market in a big way, evidenced by its $11 billion in home loans as of December 2012. Despite the credit risks associated with home lending, lending is likely to be a key growth market for the company in the future.

Unlike Schwab, TD Ameritrade Holding Corp. (NYSE:AMTD) has not strayed very far from its trading roots, with the segment accounting for roughly 40% of its total revenues in its latest fiscal year. The company courts its core, active trader customer base with a range of online research and trading tools, with the goal of improving its customers’ access to information and ideas. It has also been catering to the registered investment advisor market, an area dominated by Schwab’s institutional unit.

In FY2012, Ameritrade posted weak financial results, with decreases in revenues and operating income of 4.4% and 10.9%, respectively, compared to the prior year. The company was hurt by the same industry trends that affected Charles Schwab Corp (NYSE:SCHW)’s business, namely low retail trading volumes and low yields on its float. While Ameritrade hasn’t gone the proprietary bank route, it has a cooperative relationship with major investor TD Bank, which provides a steady stream of customer deposit fees. Unfortunately, without a major shift in customer trading patterns or business strategy, TD Ameritrade Holding Corp. (NYSE:AMTD) seems likely to tread water for the foreseeable future.

E*Trade certainly won the advertising wars with its lovable baby trader, but not much else has gone right lately. The company almost went bankrupt during the financial crisis, ultimately surviving due to a large capital infusion by Chicago-based hedge fund Citadel. E*Trade’s troubles stemmed from its ill-timed, highly leveraged move into the home lending market, a problem area that management hopes will dissipate with the passage of time.

In FY2012, the company reported mixed financial results, with a 7% decline in revenues and a 6% gain in operating income. The company’s top-line was hurt by its customers’ weak trading activity and its lack of a presence in the professional advisor segment. While E*Trade’s operating margin improved significantly, due to a reduction in loan loss provisions, half of its $10 billion in home loans have a 100% loan-to-value ratio and may create further trouble down the road. Citadel may see value in E*Trade, but the company will be hard-pressed to catch its larger competitors.

The discount brokers had their day in the sun, but their core businesses are currently weathering difficult times. While Charles Schwab Corp (NYSE:SCHW) has the best industry position, with its 300 branches and multiple revenue streams, all of the firms are struggling to find growth in the current environment. Until the Federal Reserve changes policy, investors would be well-advised to move on.

The article Sizing Up the Discount Brokers originally appeared on Fool.com.

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