E-Trade may be good speculation selection

It’s so easy to kick discount broker E-Trade (Nasdaq: ETFC) when it’s down. Standard & Poor’s Ratings Services is downgrading its debt.

Yes, the picture is ugly. Regulators want the company to raise new capital as it continues to pay for its aggressive online banking mistakes. With $8.1 billion in debt, E-Trade’s balance sheet won’t win any beauty pageants. Its income statements aren’t any prettier, with seven consecutive quarterly losses.

But when will E-Trade be given credit for its growth? It tacked on 32,550 net brokerage accounts in April alone. It now sports a record 4.5 million accounts.

It’s struggling in attracting new banking accounts, but that’s not a surprise. E-Trade’s bread-and-butter Complete Savings Account has gone from yielding 3.01 percent at the beginning of the year to a puny 0.95 percent recently.

If the growth is gravitating toward its discount brokerage business, that’s a good thing. Many of E-Trade’s peers, such as TD Ameritrade, are consistently profitable.

The hurdles along the way – billions in debt, deficits projected to continue in the near term and regulator capital requirements – won’t be easy to clear. However, at this price (down more than 90 percent over the past two years), and with so much potential upside if it catches up to its discount-brokerage peers, it’s an intriguing speculation. Proceed with caution, though.

Ask the Fool

Q: Should I avoid companies with low profit margins? – T.F., Tampa, Fla.

A: In general, higher-margin companies are more promising than lower-margin ones. High margins can reflect some competitive advantages, such as a strong brand. Also, amid a price war, companies with higher margins have more wiggle room. Still, you shouldn’t necessarily avoid lower-margin businesses.

Imagine that Buzzy’s Broccoli Beer (ticker: BRRRP) has a whopping net profit margin of 28 percent, while Scruffy’s Chicken Shack (ticker: BUKBUK) has only a 2 percent margin. If Buzzy’s sells only five beers a year, while Scruffy’s sells out of chicken each week, Scruffy’s may well be the better buy, generating more cash in total than Buzzy’s.

Some industries, such as software, typically have high profit margins. Discount stores and supermarkets typically have very low ones – but if they turn over inventory fast enough, they might still be good investments. Wal-Mart’s margin, for example, is around 3 percent.

My dumbest investment

My dumbest move was leaving a lot of money in my former company’s stock. I did this after talking to a professional stock analyst who worked for a hedge fund. The fund owned about 7 percent of the company’s stock. He told me that according to his analysis, the stock, which was trading around $18 a share, was worth about $30 with the current management and would be worth $50 with better management. It’s now selling for about $2. I paid a high price for not diversifying enough. Part of what made the company valuable was that it sat on some once very valuable real estate in California. – J.G.T., Queen Creek, Ariz.

The Fool responds: It’s important to understand that not all stock analysts are good ones, and even the good ones are wrong sometimes. In addition, as you now know, it’s risky to have too much of your money in one stock, even your employer’s. Remember what happened to Enron workers. Even employees at companies such as International Paper and Whirlpool have suffered through prolonged slumps or stagnation.