Here’s Why E-Trade’s Interest Income Is Its Largest Value Driver
E*Trade Financial (NASDAQ:ETFC) fared well in 2017, with over 20% growth in revenue in the first 9 months of the year and a more than 40% surge in its stock price over the year. We attribute this growth primarily to revenues from interest earning assets. This revenue stream continued its strong performance throughout the year, in large part due to the Fed’s rate hikes over recent months and the expectation of further interest rate hikes in the near term.
We estimate that E-Trade’s Interest Income accounts for around 67% of its valuation, over 3x the value contribution of its trading commissions. We have created an interactive model that details how changes in asset base and yield on these assets can impact E-Trade’s share price. You can modify these assumptions to see their impact on the company’s valuation.
We have a price estimate for E-Trade’s stock of about $43, which is slightly below the market price.
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Interest Earning Assets
E-Trade’s Interest Earning Assets are largely comprised of loans, mortgage-backed securities and investment securities. The improvement in the U.S. economy led to the interest rate hikes, which in turn contributed to growth in the company’s interest earning asset base. We currently forecast steady growth in these assets through our forecast period, eventually reaching $80 billion. However, should the growth be slower than expected (Scenario 1) – due to intense competition and tepid returns – and these assets remain around $65 billion in the long run, there would be a potential downside of 10% to our price estimate for the company’s stock. Alternatively, if the asset base reaches $100 billion (Scenario 2), it could boost the valuation by 5%.
Net Interest Yield
E-Trade’s net interest yield has been around 2.65% in recent years, primarily influenced by the interest rate hikes since 2015. Demand for loans was weak in the years following the financial crisis. We expect U.S. non-revolving consumer credit to see growth going forward as macroeconomic conditions continue to improve, which should lead to an increase in assets and yields. With the Fed’s rate hikes underway, we expect yields to rise to around 3.1% by the end of our forecast period. However, if the interest rate hikes take longer than expected, and and the net yield only rises to about 2.75% during the same time-frame (Scenario 3), there would be a downside of 8% to our price estimate. Alternatively, if the net yield crosses 3.5% (Scenario 4), it could boost the company’s valuation by 8%.
See Our Complete Analysis For E-Trade Here
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