2024-01-05 02:14:51 ET
Summary
- Charles Schwab's share price has increased 20% since September 2023, outperforming the S&P 500.
- The company has seen positive growth in client assets and brokerage accounts but struggles with declining interest-earning assets and bank account deposits.
- SCHW stock is downgraded to a 'hold' due to the recent surge in price and ongoing weaknesses in certain areas of the business.
Whenever there is a crisis of some sort, the value investor in me becomes intrigued by what opportunities are being discounted. Early last year, when the banking crisis began, I immediately focused myself on the financial sector. While most of my energy was devoted to the banks that are out there, particularly small regional banks, one company that ultimately captured my attention that I invested in on a short-term basis was The Charles Schwab Corporation ( SCHW ). In addition to having its own banking operations, the company serves as a massive brokerage house. In terms of overall assets controlled, it is one of the largest financial institutions on the planet. Even though some weakness persisted throughout much of last year, the company was seeing many signs of positive growth. And since I last wrote a bullish article about the firm in September of 2023, shares have skyrocketed 20% at a time when the S&P 500 is up only 6.5%.
Fast forward to today, and I do think that the easy money and the institution have probably already been made. That increase in share price, combined with some continued pain on both the top and bottom lines for the company, has made me feel as though investors might be better off looking for opportunities elsewhere. Now, I wouldn't be surprised if shares do climb further from this point on. This would be especially the case if the broader market also continues to appreciate. But I think that relative to the risk assumed, there are better candidates to be had these days. Because of that, I am now downgrading the stock to a 'hold'.
A look at the good and the bad
Author - SEC EDGAR Data Author - SEC EDGAR Data
Even though I have decided to downgrade shares of Charles Schwab, this does not mean that I think it is a bad prospect for long-term investors. I just don't think it is a prime prospect. In many respects, the company continues to post really attractive results. Consider, for instance, the total client assets that it had custody of in November, which is the most recent month for which data is available. Thanks to net new assets flowing in from clients totaling $19.2 billion and $508 billion in gains associated with the stock market rallying, total client assets hit the second-highest point on record at $8.18 trillion. This was only slightly shy of the $8.24 trillion all-time high that the company reported for July of last year. Since July, the firm has been hit by three months in a row of continued losses associated with asset prices falling. But the surge seen in the market in November, combined with $59.5 billion in aggregate net new assets, helped reverse the course.
Even more impressive to me than that is how the brokerage side of the company specifically is doing. For starters, management reported 286,000 new brokerage accounts coming onto the platform in the month of November alone. This is actually near the low end of the historical range for the firm. But it is still a massive increase when you consider how mature the trading space is often considered to be. In the first eleven months of 2023, the firm has added 3.47 million brokerage accounts, averaging about 315,000 each month. Of course, not all of these have proven to be active brokerage accounts. But even on that front, Charles Schwab is doing remarkably well. The firm hit an all-time high of 34.67 million active brokerage accounts in November. That's 101,000 more than what it had in October. That 101,000 addition was actually the largest month over month increase dating back to April of 2023 when the company added 128,000 active brokerage accounts.
It's important to keep in mind, of course, that not everything regarding the institution has been positive. As an example, average interest-earning assets have long been on the decline. To put this in perspective, back in June of 2022, the company had $614.10 billion of average interest-earning assets. That number has decreased almost every month since then. As of November, the metric was down to $439.12 billion. However, it is worth noting that that is a slight improvement over the $438.52 billion reported for October. Interest-earning assets are important because they are the assets upon which management can earn interest income. Not only is this high margin in nature, but it's also a significant amount of money when you're talking about hundreds of billions of dollars.
Speaking of interest-earning assets, one of the biggest pains for the company has been the amount of assets that it has in the form of bank account deposits. Historically speaking, bank account deposits have been a source of cheap capital for financial institutions. The companies in question pay almost nothing for this capital and are able to lend it out at rates that, by comparison, are significantly higher, capturing the spread in between after factoring in any loan write-offs or investment write-offs that are required. But in this high interest rate environment, institutions are competing for deposits and clients are looking for alternative ways to capture yield.
Unfortunately, Charles Schwab has not been particularly successful in preventing bank account deposit outflows. Back in June of 2022, the institution had $155.6 billion worth of bank account deposits. Every month since then, this number has dropped, hitting $93.7 billion in November. Hopefully, as interest rates drop later this year, this picture will change. Although it is far more costly than bank account deposits, the good news is that the firm has benefited from a surge in money market funds. Over the same window of time, these have skyrocketed from $168.5 billion to $469.6 billion.
The changes in financial condition that the company has seen, combined with a continued drop in trading revenue caused by trading fee compression and a reduction in trading activity, net revenue for the institution both for the most recent quarter and for the first nine months of 2023 relative to the same time one year earlier, has been on the decline. This can be seen in the charts above and below. This weakness has also, in turn, pushed profits down as well. For the first nine months of last year, for instance, the company generated $3.72 billion in net profit. That's down quite a bit compared to the $4.81 billion generated at the same time last year. But even so, we have a company that's generating billions of dollars per year in profits. So I could hardly call the situation awful.
Takeaway
All things considered, it seems to me as though there are both positive and negative aspects that investors should weigh carefully before deciding whether to buy the stock or pass up on it. In the past, I have been bullish on the company. In the long run, I suspect that the picture will still be fine. But the recent surge in price, combined with the continued weakness when it comes to bank account deposits and both the top and bottom line for the institution, has led me to now downgrade the firm to a 'hold'.
For further details see:
A Mixed Picture For Charles Schwab Warrants A Downgrade At Last