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Analysts pit Ameritrade against E*Trade

The two online brokerages have substantially different business strategies, but which one is right for investors?

Investors have beaten up shares of online brokers in recent months, leaving some wondering which business model is the better road map to profits.

Concern over the industry's prospects has driven down some marquee names. E*Trade has fallen about 37 percent this year. The stock trades around $16, closer to its 52-week low of $13.12 set May 24 than to the stock's high of $40.

Ameritrade has slipped 31 percent this year and hit a low of $10.50 on May 24 compared with its high of $31.

"They have two very different strategies, and the jury is still out on which is best," Josephthal analyst William Wong said.

Deutsche Banc Alex Brown analyst Glenn Schorr initiated coverage on both companies last week. He rated E*Trade at "market perform" and gave Ameritrade a higher "buy" rating.

Ameritrade wants to capture customers who demand fast and inexpensive Internet stock trades. The strategy has paid off, with heavy advertising and low transaction costs--about $8 a trade. Schorr reckons that 70 percent of Ameritrade's revenues come from trading activities.

E*Trade generated 65 percent of its net revenue from trading activities during the recent quarter, but it wants to diversify.

Volatile market volume makes proceeds from trading commissions risky; if market volume dries up, so does revenue. Expanding into other business could "blunt the hit they might take on narrower trading volume," Wong said.

E*Trade wants to offer a broader range of services to its customers, such as online banking and trading on international markets, to transform itself into a "financial services powerhouse."

"While its peers, such as Ameritrade, have focused on being the most cost-effective providers of quality execution services," Schorr wrote in his report, "E*Trade has taken a much more aggressive approach in building a comprehensive financial services offering."

E*Trade has deposit, insurance, loan and credit card offerings; soon it will add government-insured cash management accounts, business checking, consumer and business lending, expanded insurance and credit offerings, and a revamped bond center.

Schorr thinks E*Trade stock is less valuable than Ameritrade's: Although E*Trade's strategy might work someday, diversification is cash-intensive in the short haul, he said. According to Schorr, the company has made over $2 billion in investments in outside companies to build its service offerings.

"E*Trade has more obstacles to get through in the short term," Schorr said. "They have to market themselves in 12 countries...and tweak their brand a little bit in the United States" to get more attention.

The average E*Trade account made four trades in the June quarter and contained nearly $21,000 in assets. Ameritrade customers made seven trades for the quarter and held about $30,000 in assets with the company. Charles Schwab boasted accounts with average assets of over $100,000.

"Investors are focused on profits today," Schorr said, "and assuming industry growth continues, we think Ameritrade can bring a bigger piece to the bottom line." At the end of fiscal 2001 in September, Schorr predicts E*Trade will make 21 cents a share in fiscal 2001 compared with Ameritrade's 91 cents.

Yet Schorr also believes that E*Trade has the potential to be a market leader. "In the long run, (E*Trade) might be better off, but it's going to be choppy in the near term," he said.

Yet if money can be made on the Internet, financial services could lead the way. Financial service companies manage data, which is relatively easy to store and send. By contrast, online retailers of books or music must spend vast sums of money to ship, handle and warehouse their products.

"When you look at products over the Internet, I think financial services is the sweet spot," Wong said. "It's a product that can be digitized or broken down into bits and bytes."