2023-10-13 09:00:01 ET
Summary
- Charles Schwab Corporation investors have experienced another frustrating bear market decline, with the stock dropping to lows last seen in May 2023.
- Despite positive commentary and strong operating performance in Q2, investors have been struck with fear and have fled for safety.
- The recent decline in SCHW's stock may indicate selling exhaustion, allowing investors who missed the bottom earlier in 2023 another chance to add exposure.
- I argue while the market is justified to inflict pain recently, SCHW could be near its bottom as it inches closer to an inflection point.
The Charles Schwab Corporation (SCHW) investors have had to endure another frustrating bear market decline (> 20% decline) since my previous update . As such, SCHW has dropped to lows last seen in early May 2023 before the surge toward its July 2023 highs.
I had previously expected a downward reversal, highlighting overbought sentiments. As such, I reminded investors to anticipate a possible pullback. Notwithstanding my caution, I didn't expect investors to be struck with so much fear, leading to SCHW enduring another steep decline as buyers fled for safety.
But why? Didn't management's positive commentary and more robust operating performance in Q2 assure investors about Schwab's wide-moat business model? Moreover, Schwab remains a highly profitable company, notwithstanding the significant headwinds from cash sorting and fears about its unrealized losses on the investment securities on its balance sheet.
Moreover, with the worst fears of the regional banking crisis gradually fading away, why aren't investors feeling more confident about a company with a best-in-class profitability grade of "A+," as rated by Seeking Alpha Quant?
Furthermore, Schwab's adjusted operating margin is still expected to reach 39.5% for FY23. While it's down significantly from last year's 50% metric, analysts expect Schwab to climb out of its nadir, seeing progressive improvement to its operating earnings, with its adjusted operating margin recovering to 51.2% by FY25.
However, I've learned not to argue with the market. Instead, we should learn and assess whether SCHW's recent bear market decline has reached another possible inflection, suggesting selling exhaustion could be near. The recent headwinds from surging Treasury bond yields and the Fed's higher-for-longer positioning have likely caused market operators to take profits rapidly, given the sharp surge toward its July highs from its May 2023 lows.
Furthermore, the recent attrition relating to the migration of TD Ameritrade could also have spooked investors. However, management has clarified that it doesn't expect sustained and significant net flow headwinds from the migration, impacting its revenue generation capabilities. Despite that, I believe investors are justified in reflecting a much higher level of execution risks, as Schwab's earnings capabilities could take much longer than anticipated to recover, given the high-interest rates, which also impacts its cost of funds.
SCHW Quant Grades (Seeking Alpha)
SCHW still boasts an "A-" growth grade, which I believe justifies its premium valuation of "D-" relative to its sector peers. Notwithstanding my optimism, the market has had other ideas, likely focusing on its ability to recover its adjusted operating margins before the regional banking crisis this year.
As such, investors have likely baked in a more challenging operating environment, culminating in its bear market decline since my previous update. Schwab is scheduled to provide its Fall business update on October 16. As such, all eyes will be on management's commentary concerning the challenges that I enunciated earlier.
SCHW fell nearly 30% from its July 2023 highs toward its lows last week. The magnitude of the decline has likely stunned even Schwab's most ardent supporters and investors.
However, bears are right to point out that Schwab's high unrealized losses on its investment securities could affect its regulatory capital ratios if the regulators decided to make substantial changes. I believe the caution is warranted. Furthermore, Schwab's cost of funds could worsen, leading to a double whammy as its cash sorting woes continue if the Fed stays higher for longer. As such, execution risks leading to a slower earnings recovery need to be priced in.
However, SCHW has fallen back to highly attractive levels, with a forward adjusted P/E of 15.5x (well below its 10Y average of 21.5x). As such, I'm leaning further with the bulls, confident that SCHW should not re-test its May lows. I expect SCHW to consolidate close to its October 2023 lows before a further recovery is in store.
Rating: Maintain Buy.
Important note: Investors are reminded to do their due diligence and not rely on the information provided as financial advice. Please always apply independent thinking and note that the rating is not intended to time a specific entry/exit at the point of writing unless otherwise specified.
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Charles Schwab: Investors Struck By Fear Ran For Cover - Here's Why I Didn't Flee