Should Investors Buy Shares Of Discount Brokers?

The COVID-19 pandemic ushered in a new group of individuals who traditionally stayed away from stocks. New traders and investors with minimal to no market experience started using retail stock brokers that offer free or very cheap services.

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This trend was not unique to the United States. For example, stock brokers in Canada have seen massive growth in customer acquisitions as the Canadian dollar fell in value versus the American greenback. Similar to America, Canadian newbie traders and investors were attracted to what seemed like rock-bottom stock prices found in the Toronto stock exchange and others worldwide.

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Savvy investors that are always on the lookout for opportunities are questioning if the surge of retail trading and investing activity bodes well for the stockbroker tickers.

Where The Growth Came From

By some estimates, retail investors and traders accounted for just 10% of stock market activity in 2019 but the participation rate more than doubled to 25% by July 2020. There are many reasons that help explain the new interest from retail investors and traders.

Historic job growth and record low unemployment over the past few years left people with more cash to invest. People who avoided the stock market were suddenly presented with a unique opportunity to buy shares after the COVID-19 pandemic prompted a plunge in stocks in March.

Part of the growth in retail activity can also be attributed to the millions of people who couldn’t bet on live sports. Barstool Sports founder and CEO Dave Portnoy live-streamed his new hobby of day trading stocks to his millions of social media followers and convinced many to fill the void.

Experts agree Portnoy helped convince bored sports bettors to start betting on stocks:

“The rush of retail investors into U.S. equities is at least partly a function of a world with no casinos, no sports betting to speak of, and little to do outside the home,” DataTrek co-founder Nick Colas said. “The dopamine rush of a full house is the same as holding a hat-sized stock into an up 3% open on the S&P.”

How Investors Can Benefit

Investors who believe that the rush of retail trading activity will stay can profit by investing in some of the public stock brokers. Here is a brief roundup of some of the more notable stock broker tickers that investors can buy.

  • Charles Schwab (ticker SCHW) agreed to acquire rival discount broker TD Ameritrade (ticker AMTD) in 2019. At the time of the acquisition, the companies said the combined entity will serve 24 million clients that boast more than $5 trillion in assets. The new company will be in a better position to lower operating expenses and improve its competitive standing.
  • Similarly, Morgan Stanley (ticker MS) acquired E*Trade Financial (ticker ETFC) in early 2020. However, Morgan Stanley is a mega Wall Street bank with multiple products and services. As such, it is far from a pure-play stock that gives exposure to the surge in new retail activity.
  • Interactive Brokers Group (ticker IBKR) noted in its second quarter results (July 21, 2020) that it saw higher commission revenue from increased trading activity. The company serves both individual retail investors and traders along with hedge funds and other entities.

Where Is Robinhood?

Absent from the list of stock brokers to invest in is Robinhood, the still-young startup was among the first to offer clients commission-free trades and fractional share ownership.

Robinhood is still a private company so it’s stock does not trade on any public exchange. The company only opens itself to investments from venture capital firms, including some of the biggest names in the industry like Sequoia and Kleiner Perkins.

As such, Robinhood has no immediate need to become a public company since it has zero problems raising capital in the private market. The most recent capital raise consisted of a $200 million Series G funding round from D1 Partners in August 2020. In total, Robinhood collected $1.7 billion in cash from its consortium of investors.

Robinhood disclosed it oversaw 4.3 million daily average revenue trades (DART) in June. This happens to be double the number of combined DARTs Charles Schwab (1.8 million) and E*Trade (1.1 million) reported over the same month.

Robinhood is also outpacing TD Ameritrade in terms of DARTs at 3.34 million.

Clearly, the startup is beating the legacy industry titans at their own game. Unfortunately, retail investors are missing out on a tremendous growth story while venture capital firms stand to potentially make billions from Robinhood's growth as a private company over the coming years.

Conclusion: Don’t Forget The Dangers

Prior to investing in a retail stock broker, investors should be aware of some of the reasons to avoid such a move. Since the rise in retail trading was in part fueled by bored sports betters, it would be reasonable to assume many will be closing their accounts when the NFL kicks off shortly so they can return to their betting niche. This would lead to a decline in revenue and profit in the future.

Also, retail customers tend to have little to no loyalty to their platform so major blunders can see an exodus of clients. These events are uncommon but when it does happen it tends to be serious. Most recently, TD Ameritrade’s desktop retail trading platform was offline for two days near the peak of the market’s rally in August. This likely contributed to an exodus of customers flocking to a rival platform.

Bottom line, a certain degree of caution should be exercised before buying any retail stock ticker. But such is the case for every investment decision.