E*TRADE Financial (ETFC – Nasdaq)

Dear Bottarelli Research Member,

Welcome back! As we begin another year of small-cap investing, Bryan and I have some extremely exciting plays in store for you. In fact, as Bryan said last Friday, SOLF increased much further than we expected, so I hope that you took all of your profits off the table. After all, the market is still very volatile. Oil is trading at or near $100 per barrel and the ongoing threat of a recession is now being mentioned on every daily news show. This is making investors across the country very nervous. As a result, we’ve seen some rather significant downside moves to begin the 2008 trading year – and that’s why Bryan will be recommending a layer of downside protection via a new DIA put position in his commentary below. But despite the irrational, fear-based selling pressure, I’d like you to take a deep breath and realize that this is a time when great opportunities present themselves.

Speak to any super-star investor, and they’ll tell you that staying calm and rational in the midst of an irrational market is where the biggest opportunities are discovered. And starting in 2008, that’s exactly what Bryan and I will be doing for you. In fact, over the holidays, I had the pleasure of meeting with my own inner circle, and I can tell you that the bullishness in certain sectors caught me completely off guard.

Since we were able to meet face to face, we had the pleasure of talking in depth about the current market situation – and I must say – there is now some very contrarian thinking going on amongst the most brilliant minds in the investing world. So, to kick off the 2008 investing year, I’ll be recommending one company that fits this contrarian mold to a “T.”

They’re involved in exactly what we do, which is buying and selling stocks. Due to poor management decisions that got them exposed to sub-prime mortgages, this stock has been beaten up drastically. But they’re not a mortgage lender. Far from it. Just recently, their CEO was asked to leave, their sub-prime issues were fully disclosed, and a new operational plan was devised to unlock the company’s true value moving forward. Plus, this company has a large and loyal customer base, and this could very easily draw takeover or acquisition interest.

With overseas investment companies like Dubai Investments constantly on the prowl for under-valued U.S. companies, it makes perfect sense for these firms to take a position in any sustainable company with a dramatically low valuation. Just today, for example, Bank of America agreed to buy Countrywide Financial for $4 billion (entirely in stock) to become nation’s top mortgage lender. That tells you that the takeover and acquisition interest could soon be knocking at this company’s door. After all, this was a $25.00 stock just last year. Now it’s trading for $3.10. But by year’s end I truly think it’ll be trading back in the $6.00 to $9.00 range. That’s making money folks, plain and simple.

This week’s pick is E*TRADE Financial (ETFC – NASDAQ) and with it now selling under $3.20 per share, let’s dip our toe in the water. Now please understand, this is a pure contrarian play. We’re buying when everyone else is selling. But like I mentioned above, smart investors like us must stay calm, see value, and execute our game plan while blood is running in the streets. With ETFC trading for only $3.20 per share, it looks like a steal. Any news of a U.S. merger or an overseas majority investment and you can bet that the shares will take off. Let’s take half of a position in ETFC under $3.20.

INVESTING NOTE: ETFC also has options available, so if you prefer using longer-dated options on plays like this, you may consider buying the ETFC January 2009 5.00 Calls (ONY AA) for under $1.10. They’re currently trading $0.85 to $0.95 per contract.

UPDATES

ISIS Pharmaceuticals (ISIS – NASDAQ): What a great way to start the year! Genzyme (GENZ – NASDAQ) and Isis Pharmaceuticals announced that they have entered a major strategic alliance in which Genzyme will develop and commercialize “mipomersen,” which is ISIS’s lipid-lowering treatment for high risk cardiovascular patients. Given this upside move, I want you to take 1/3 of your profits off the table over $18.00 and then hold the rest for more gains. This is just the tip of the iceberg for ISIS, but we might as well lock in a little profit off this week’s great gain.

Fushi International (FSIN – NASDAQ): Over the holidays, FSIN ran up to $27.69 and we saw a 43.84% gain from our original buy price. If you were able to lock in a portion of your profits by selling half of your position, then congrats on another nice winner. If not, FSIN has once again pulled back giving you yet another chance to own it. I remain bullish. Buy.

Origin Agritech Limited (SEED – NASDAQ): As you all know, we put this one on a “short leash” towards the end of 2007, and boy have they turned things around! I still believe that “soft commodities” are where we want to be, since growers worldwide will continually need seeds to plant their crops. Plus, my inner circle is extremely bullish on cotton, and guess who makes the finest cotton seed used overseas? SEED! Stay with this one, and if you bought on the lows, my hat goes off to you. Excellent trade!

Echelon Corporation (ELON – NASDAQ): ELON also made a very strong come back, but it has now given some of its recent gains right back. I would once again take advantage of this dip and view it as a buying opportunity. Energy conservation is on every company’s agenda, and ELON has exactly the software to make it happen worldwide. Buy.

SiRF Technology Holdings (SIRF – NASDAQ): After seeing a nice pop, SiRF has now pulled back alongside everything else. On a global scale, cell phones utilizing SiFR’s navigational chips are flying out of stores, and this makes me stand pat on my bullish thesis. FSIN remains a buy.

Terra Nostra Resources (TNRO.OB): TNRO continues to hold up well. They’re getting closer to the spin off of Sino Strategic Metals, which means they’ve met their financial obligations in the funding of the joint venture, and they’re now awaiting the listing on the Hong Kong Exchange (which is projected for mid 2008). Stay tuned because this one should be very interesting. Hold.

Sinovac Biotech (SVA – AMEX): SVA is receiving great results from their phase 2 trials of their Bird Flu vaccine. After a 402-volunteer study (with members ranging in age from 18 and 60), the Chinese FDA concluded that a SVA’s split H5N1 vaccine is safe for human use. That means they can now move forward and produce the total vaccine doses that are needed – putting them in the lead position to have the first-ever Bird Flu drug backed by the Chinese FDA. We’ve already taken 100% gains off the table on SVA, and now that it has pulled back we could have another chance for profits coming soon.

Uranium Resources (URRE – NASDAQ): Although uranium prices have fallen hard, we’ve had a very nice run on URRE in 2007, and I think the upside will continue in 2008. With oil prices remaining close to $100, both natural gas and nuclear energy will become more important than ever. Therefore, I fully expect to see the price of uranium move up again, and this will provide a boost to both URRE and Uranium Energy (UEC – AMEX). I remain bullish on both companies.

Graham (GHM – AMEX): Please be aware that the stock split 5:4 on January 3^rd, which means you now own 5 shares for every 4 that you previously owed. Bryan and I both consider stock splits to be bullish indicators. They increase liquidity and express a bullish management sentiment. GHM continues to lock in more and more orders, so the stock remains very strong. Hold for more gains.

E-House Holdings (EJ – NYSE): On Thursday January 10^th, EJ announced a strategic cooperation arrangement with three leading real estate developers in China – including Vanke (China’s largest real estate developer). This is HUGE. Under this arrangement, E-House will be the exclusive sales agent for 16 existing projects in 10 cities, and this announcement has already helped push EJ 16.75% above our December 14^th entry price. Things are looking really good here, so continue to hold for more gains.

POST-SELL FOLLOW UP

After our sell recommendation was issued on Lighting Science Group (LSGP.OB), the stock make a nice upside push. If you still own shares, then 2008 may be the year they shine, especially with the new energy bill taking affect. I still own these shares because of my own personal belief in what’s to come, so feel free to write for any continued guidance.

Sincerely,

The Carnage Has Been Overdone

“When Cramer Says Sell, I Look to Buy”

Over the last six months of Bottarelli Research Small Cap recommendations, I must admit that today’s E*TRADE Financial (ETFC – NASDAQ) pick sparked the longest conversation between Mark and I. The reason for our lengthy discussion was simple:

I was skeptical.

But the more Mark and I hashed it out, the more the investment thesis made sense – so I’d like to take a shot at owning a small position in ETFC at current levels. My reasons why are outlined below, but first I’d like to recommend a way that you can protect your small-cap ledger against any violent market sell-offs. This layer of protection comes in the form of February put options on the Dow Diamonds (DIA – AMEX).

I tend to think of the DIA as the Dow’s version of the QQQQ, which means that the movements of the DIA generally correspond to the price and performance of the Dow Jones Industrial Average. Specifically speaking, I’d like you to add DIA February 128 Puts (DAW NX) anywhere under $4.30 per contract. If the market really takes a turn to the downside, you’ll be glad that you’re holding these puts in your back pocket. So as a protective measure against our small-cap holdings, here’s the play:

PROTECTIVE PLAY: Buy DIA February 128 Puts (DAW NX) at or under $4.30, good for the week.

On an intra-week basis, if these puts trade 35% to 40% above your entry price, don’t wait for me to issue the sell alert. The moment they hit your gains target, take your money and run!

Now let’s get back into E*TRADE Financial…

We’ll begin by looking at the stock movements of some of the top mortgage lenders. Starting on July 10^th 2007, Fannie Mae (FNM – NYSE) closed at $66.49. Today it trades for $32.32, good (or not) for a 51.4% loss.

Also on July 10^th 2007, Countrywide Financial (CFC – NYSE) closed at $37.34. Today it trades for $5.01, marking an 87% loss.

So, two of the biggest mortgage lenders in the country have lost 51% and 87% of their value since July 10^th. Now remember, CFC and FNM are companies with business models surrounded entirely in lending – and their recent stock price movements have been rather painful.

But now let’s consider E*TRADE…

On July 10^th 2007, E*TRADE Financial (ETFC – NASDAQ) closed at $ 22.93. This week, it traded for $2.38, giving it a 90.4% loss! In fact, this was E*TRADE’s lowest level since 1996 – making them the worst performer on the entire Standard & Poor’s 500 index.

When I see a reaction like this, I can’t help but think that Wall Street is treating E*TRADE like a mortgage lender – not an online stock broker. Now I admit, the company got caught up in business segments that they should NOT have been involved in – notably the sub-prime lending sector. And as a consequence, the stock is paying dearly. Just look at this chart:

But as I write you today, there is a good chance that all of the bad news has now been factored into the stock. In fact, when E*TRADE reports their Q4 earnings on January 24^th (which are expected to show a $2.89 loss), they’ll also unveil the full details of their new restructuring plan aimed at reducing balance sheet risk and lifting shares off their all-time lows. In fact, some rather important moves have already been made.

In November, for example, ETFC sold a portion of their mortgage portfolio to Citadel Investment Group and secured a $2.55 billion cash infusion. This sale included a combination of mortgage securities and municipal bonds, and substantially reduced their debt levels. E*TRADE also recently sold $3 billion of mortgage-backed securities and municipal bonds, which got them off the hook of these obligations for the manageable loss of just under $5 million. Not only that, but they’ll also exit their institutional trading business – which means E*TRADE will solely focus on what they should’ve been focusing on all along: Their retail banking and brokerage operation.

Getting back to their core brokerage business will be the first and most important step to turning their stock price around. In fact, according to acting Chief Executive Jarrett Lilien, “We have taken important steps in the execution of our turnaround plan by reducing balance sheet-related risk and maintaining strong bank capital levels.”

Now, the closure of their institutional trading business and the sale of their securities and bonds will help E*TRADE reduce their risk, but it’ll also reduce their near term revenue streams. But that’s fine. After all, remember that all of this bad news has already been factored into the shares. Take Merrill Lynch (MER – NYSE) for example. Just this morning, MER said that they’re expecting to suffer $15 billion in losses stemming from their mortgage investments, yet the stock gained 4.5% on this news. This reaction is a clear illustration of what happens when all of the bad news is priced into a stock. Plus, as a shareholder, I’d much rather see a company give up near-term revenues to fully correct their long term structural and operational problems – setting the stage for a much more promising future. That’s exactly what E*TRADE is doing.

Another interesting point: The perception on Wall Street is that E*TRADE has been hemorrhaging assets as their customers jump ship. You see, several brokerages recently raised concerns that ETFC’s slumping client assets could hurt the company’s profitability. But contrary to this market rumor, E*TRADE actually added 87,000 gross new accounts in December. Plus, their total client assets at year-end were $190 billion compared to $192 billion a month earlier. So if there was any reduction in client assets, it certainly wasn’t as severe as advertised. Therefore, I feel that a re-commitment to their online brokerage business – combined with the elimination of their troubled business operations – could be all it takes to spark a turnaround in the shares. Heck, all we need is the stock to move from $3.20 up to $4.80 and we’ll have a 50% gain on our hands. We could easily see this type of reaction in the first 3-6 months of the year. Mark feels that the shares could get as high as $9.00 in 2008, which could be a 183% gain off current levels! And when you look at the financial numbers driven from their online brokerage business, it’s easy to see why Mark feels $9.00 could be an achievable target in 2008.

Consider this comparison…

E*TRADE has a P/E ratio of 2.82. That is ridiculously low when compared to Charles Schwab’s P/E of 11.59 and TD Ameritrade’s P/E of 18.00. On the same hand, E*TRADE’s Price-to-Sales ratio of 0.48 also looks ridiculously low compared to Schwab’s P/S ratio of 5.53 and TD Ameritrade’s P/S ratio of 5.51. Plus, in terms of profitability, E*TRADE’s trailing three months revenues of $2.11 billion actually came in higher than TD Ameritrade’s three months revenues $2.06 billion!

When you see valuations like this, Mark’s $9.00 price target makes sense. After all, if E*TRADE can get their current valuations to just half of those of TD Ameritrade or Charles Schwab, then ETFC could quickly jump 50% to 100% by Q3 2008. That’s why I feel it’s worth a shot to add a small position at these levels.

Now remember, this is a pure “recovery” play that has the ability to jump rather quickly. And further supporting the “quick jump” thesis is that fact that 53 million shares of E*TRADE are currently sold short. This amounts to 12.80% of their total float – which could spark a major short-squeeze that pushes shares aggressively higher. In fact, the first leg of this upside could have already started this week. That’s why I feel that a re-focus on their online brokerage business could quickly get E*TRADE back to the same levels of Charles Schwab and TD Ameritrade – and therefore the time to enter a small position is now.

I’d like to recommend that you buy half of your normal small-cap position and add shares of E*TRADE under $3.20. Should the stock move up to $4.40, don’t wait for our signal – take your 40% profits and sell! Using that setup, here is your first small-cap play for 2008:

PLAY: Buy shares of E*TRADE Financial (ETFC – NASDAQ) at or under $3.20, good for the week.

I almost forgot to mention something…

While Mark and I were discussing this recommendation over the phone, Jim Cramer appeared on the TV. He responded to a customer question about E*TRADE by telling people to “sell!” Upon hearing this, Mark immediately said, “When Cramer says sell, I look to buy” and the decision to recommend ETFC was solidified!

Sincerely,