2HRS2GO: Market slide won't stop growth of online trading

Plenty has been written about over-margined, highly leveraged and otherwise shaky investors flushed out of the market over the last couple of months.

Have an opinion on this?

Figures do show a decline in volume.

Trading on the Island electronic communications network, which handles a sizable chunk of activity from online brokers, has dropped: this month's average of shares executed daily has fallen to 170.6 million shares, down about 15 percent from April, when share executions peaked at 201.2 million.

That May figure is the lowest monthly average this year. You can see a chart here.

Interest in Internet stocks has taken an especially large hit. Yesterday, Credit Suisse First Boston noted that Internet stock trading has averaged 259.7 million in May, down more than 33 percent from the previous month.

As a result, online brokerage observers are starting to ramp down their expectations. In a research note released this morning, Salomon Smith Barney analyst Michael Vetto and associate Matthew Chung cited "a sequential softening in trading volumes and recent market volatility" as reasons for cutting profit estimates on Ameritrade Holdings (Nasdaq: AMTD) and E*Trade Group (Nasdaq: EGRP), both of which were down slightly today.

Salomon's analysts now expect Ameritrade to lose 9 cents per share in fiscal 2000, compared to an earlier call of a 3 cents per share profit. Look for E*Trade to post a full year loss of 13 cents per share, or two cents more than previously estimated, say Vetto and Chung.

The Salomon team also lowered its earnings forecast for DLJdirect (NYSE: DIR), which was unchanged in early afternoon trading.

Despite their lower earnings horizons, Vetto and Chung kept upbeat ratings on Ameritrade and E*Trade. "We remain bullish on the long-term growth prospects for the industry and believe investors have the opportunity to build positions at washed out prices," the analysts write.

(They also stayed down on DLJdirect, which Salomon currently rates "neutral"; Vetto and Chung worry that the online arm of Donaldson, Lufkin & Jenrette is too small and too little known, so it has to spend more to get each new customer. On the other hand, DIR is trading near its 52-week low.)

As always, you can quibble about specific valuations. E*Trade, for instance, trades at 58 times estimated 2001 earnings, compared to a forward multiple of 35 for Charles Schwab (NYSE: SCH) and an almost 1970s-like ratio of 13 for Ameritrade.

Yet the Salomon team has the right idea in keeping an upbeat stance about online trading in general.

If you're reading this, you know individual investors aren't going away. Those volumes on Island might be at year-to-date lows, but they're also up 94 percent year-over-year. For every trader who lost everything in the last few weeks, you have several folks who kept at least the majority of their assets. They're here to stay.

I've written my share of criticism about some online investors' penchant for short-term trading, an attitude at least partly fostered by the Web brokerages.

(They'll occasionally declare their love for Buffett-style investing, but if they truly meant it, they'd offer real incentives -- like stiff penalties for high turnover in your portfolio -- instead of offering programs like PowerTrade.)

Still, I'd like to think the recent downturn watered down much of the rapid fire, trading machismo attitude. It'll never completely go away, of course, but market potholes tend to keep people in line for awhile.

And that's why ultimately, this market slump is good for the likes of E*Trade and Ameritrade. Although they'll always hope for massive trading volumes -- that's the only way their basic brokerage businesses can make money while offering relatively cheap commissions -- these negative cycles will produce a stronger base of customers.

They'll also spur online brokers to accelerate their efforts in higher margin services outside of trade execution. Then you have not only solid customers, but solid companies, as well.22GO>