TD:CC - Charles Schwab: A Stellar Earnings Release

2023-04-17 09:30:33 ET

Summary

• The Charles Schwab Corporation just released its first quarter earnings and mostly beat analysts' estimates.
• The release missed on revenue but beat on GAAP and adjusted EPS.
• Heading into the release, I was optimistic about how Schwab would perform, as JPMorgan Chase & Co. released a stellar report just a few days prior.
• In the end, Schwab proved the resilience of its business model.
• In this article, I explain why I consider Charles Schwab stock a moderately good value after its Q1 earnings release.

The Charles Schwab Corporation ( SCHW ) just repeated its first quarter earnings and mostly beat analyst expectations. The release missed analysts’ expectations on revenue but beat on EPS, both GAAP and adjusted. The numbers also showed continued strength in liquidity, with Schwab reporting very high amounts of liquid assets compared to deposits.

Going into Schwab’s earnings release, I had pretty high hopes. When I last covered Schwab, I touted the company’s strong liquidity , though I did note that its stock was a little pricey compared to its competitors.

As we saw in Charles Schwab’s first quarter earnings release, the company is still growing rapidly. Brokerage services are very profitable in this environment, owing to considerable volatility – Schwab has managed to benefit from that fact. For brokerages, volatility is a source of profit, as it leads to more trades and more fees .

Despite having an overall positive view on Schwab as a company, I’m nearly neutral on its stock. It is very richly valued for its peer group, scoring a D- on valuation in Seeking Alpha Quant. In this environment, you can find many banks with single-digit earnings multiples. Schwab is all the way up at 13.8.

With that said, my neutrality in this case is slightly bullish leaning, and I rate the stock a low-conviction "buy." I have considerable exposure to Schwab indirectly, via The Toronto-Dominion Bank ( TD , TD:CA ) shares and the Vanguard Financials Index Fund ETF Shares ( VFH ). Schwab is a very robust financial institution with enviable liquidity and a very large client base. Over the long term, its earnings should increase, and with lower risk than many banks face, too. In the ensuing paragraphs, I’ll cover the highlights from Charles Schwab’s first quarter earnings release, and explain why I consider the stock an ‘OK’ buy today.

Earnings Recap

In the first quarter , Charles Schwab delivered:

• $5.116 billion in revenue, up 10% (a miss).

• $1.6 billion in net income, up 14% (a beat).

• $0.93 in adjusted EPS, up 21% (a beat).

• $343.1 billion in deposits

• $49.2 billion in cash

• $311 billion in securities.

Both GAAP and adjusted earnings easily beat analysts’ expectations, while the liquidity situation remained strong. The book value of cash and securities combined was enough to cover 105% of the bank’s deposits, which is very good coverage – in fact, the best that I’m aware of among big banks.

In my previous article about Schwab, I wrote the held-to-maturity securities down to fair value to reflect economic reality. The first quarter press release did not have the information needed to do this adjustment, however, we can surmise that losses on HTM securities did not increase much as the 10 year Treasury yield decreased in the quarter (in other words, the Treasury increased in price).

Competitive Position

One thing that Charles Schwab has going in its favor right now is a strong competitive position. Thanks to a combination of organic growth and some shrewd acquisitions (such as TD Ameritrade), Schwab has grown its market share considerably. Today, Schwab estimates that it has 13% of all U.S. retail investor deposits, which isn’t a majority of the market but is big enough to give Schwab scale advantages over its competitors. As the U.S. brokerage industry continues to consolidate, Schwab may be able to maintain its lead over competitors, and make more accretive acquisitions like its 2019 Ameritrade buyout.

Valuation

Having looked at Charles Schwab’s recent earnings and its competitive position, we can now turn to its valuation.

At the time of this writing Seeking Alpha Quant had the following multiples on file for Charles Schwab:

• P/E (adjusted earnings): 13.

• P/E (GAAP earnings): 14.5.

• P/sales: 4.61.

• Price/book: 3.5.

The results of Schwab’s latest earnings release change some of these multiples a little. For example, now, instead of a 14.5 P/E ratio, we have a 13.8 GAAP P/E ratio. That’s fairly low by the standards of the S&P 500, but not by the standards of financials; for this reason, Seeking Alpha Quant gives Schwab a D- on valuation .

The valuation is probably the weakest part of the analysis for Schwab. This is a very profitable company that is growing fast for its sector, but it is quite pricey compared to its peers. It’s quite common in this environment to find banks trading at eight or nine times earnings. Compared to that, SCHW is an expensive stock, although it is growing a little faster than is the norm for its sector.

Risks and Challenges

As we’ve seen, Charles Schwab is a very liquid financial institution that just put out a stellar earnings release. It is a highly profitable, growing company that should perform well over the long term. Nevertheless, there are many risks and challenges for investors to watch out for, including:

• Federal reserve policy. Federal Reserve policy has an outsized impact on banks/brokerages like Charles Schwab. On the one hand, fed rate hikes increase interest rates and allow banks to collect more interest on long term loans. On the other hand, aggressive interest rate hikes can invert the yield curve, forcing banks to pay more interest on term deposits (which reduces their margins). Also, higher treasury yields can cause the “unrealized losses” issue which became such a big concern during the banking panic of March 2023. As I wrote previously, Schwab is one of the most liquid financial institutions in America; it is safer in the sense of being able to survive a crisis than most banks are. However, it isn’t invincible. If many of the bank’s depositors withdraw money then it could be pressured to sell treasuries at losses. That would diminish SCHW’s liquidity and also eat into profits, because the amount of cash banks hold partially determines how many loans they’re allowed to make.

• Declining client balances. There have been reports that Charles Schwab clients have been withdrawing funds from the brokerage. On March 13, the company reported a 28% decline in margin balances and a 4% decline in overall client assets. These declines in assets are a problem for Schwab because it’s ultimately these assets that the company earns its revenue on. Margin account balances generate interest directly, and total assets determine how much money can be made investing leftover client funds in treasuries. If these balances continue to decline, then Schwab will make less money than it would have otherwise.

• Valuation. Considered in sector-relative terms, Charles Schwab’s valuation could be considered a risk. The company is much more expensive than other banks and brokerages, and by a fairly wide margin. A 13.8 GAAP earnings multiple is unheard of among America’s other big banks. Now, partially this is because Charles Schwab is a broker first and a bank second, while its competitors are the opposite. The market volatility seen over the last 12 months has been kind to brokerages, hence Schwab’s strong earnings growth.

The Bottom Line

The bottom line about Charles Schwab’s first quarter earnings release is that it was impressive. The company’s revenue grew, its earnings beat estimates, and its overall results were received well overall by investors if pre-market trading is anything to go by. There were some areas of concern, such as a big decline in cash balances. But overall, it was a good quarter.

The question investors need to ask is, “does that make Schwab’s stock a buy?”

Although Charles Schwab is thriving as a company, its stock is very richly valued. Compared to the likes of Bank of America Corporation ( BAC ) and JPMorgan Chase & Co. ( JPM ), it is possibly overvalued. Schwab is currently enjoying better earnings growth than most banks, but that’s mainly because the macro environment of the last 12 months has been kind to brokerage services – where Schwab earns most of its money. If the market is less volatile and more stable going forward, then this company could end up making less money, or at least growing its earnings at a slower pace.

Still, I’d consider Charles Schwab a moderately good buy at today’s prices. It’s not my own financial stock of choice, but I have some indirect exposure, and I wouldn’t in principle be opposed to owning it. The Charles Schwab Corporation is doing very well, I just prefer to buy banks cheap.

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