2023-12-29 08:30:00 ET
Summary
- The Charles Schwab Corporation stock has experienced a significant rebound since bottoming out in October 2023, up nearly 47% from its lows.
- The market had already positioned for weakness heading into Schwab's third quarter earnings release, reflecting the challenges caused by the Fed's unprecedented rate hikes.
- Schwab's recent December update lent credence to my previous bullish thesis. However, investors who waited have missed the most attractive buying opportunities.
- I argue why investors must consider and learn how to assess investor sentiment/psychology in their framework to improve their chances of outperforming the market.
- With my Schwab bullish thesis playing out accordingly, I return to the sidelines and await another more attractive opportunity.
My thesis on The Charles Schwab Corporation ( SCHW ) since its initial collapse in March/April has been based on one underlying thesis: the worst has been priced in. However, the market's gyrations likely took bullish investors by surprise in July 2023, as it topped out, falling back into a bear market, before bottoming out in October 2023. Despite that, I saw another fantastic buying opportunity as the market shook out investors who feared the worst was yet to come. Why? Recall that the 10Y ( US10Y ) struck above the 5% mark in October 2023, just as SCHW and the S&P 500 ( SPX , SPY ) staged their bottom.
SCHW has since gone on a rampaging run as it retested and broke above its July highs, up nearly 47% from its October lows. Wait a minute. Did I make an incorrect observation? Did I mean to say that SCHW bottomed in October 2023 as the 10Y topped out over the same period? Yes, the 10Y topped out at 5.02% and has since fallen to 3.81% this week. Some investors might be "tempted" to point out that the Fed was why the yield dropped. Before they jump to that conclusion, let me remind these investors that Fed Chair Jerome Powell only telegraphed three rate cuts in the mid-December FOMC, nearly two months after SCHW bottomed out. Moreover, SCHW topped out at the $71.4 level in the same week that Powell highlighted the rate cuts.
In other words, SCHW investors who bought at those levels are still nursing losses, albeit slightly, since Powell's presser. In contrast, dip-buyers who bought into SCHW when the 10Y broke above the 5% mark are sitting on significant gains, outperforming the S&P 500. Any surprises? Price action investors who understand and appreciate that the market is always forward-looking will never be surprised. That makes knowing how to assess investor sentiment/psychology a fundamental aspect of a sound investing approach to outperform the market consistently.
That's the fundamental problem with a backward-looking approach to assessing Schwab's investment thesis. They focus on what has already happened, as bearish investors would likely point out that things could get worse for Schwab as the long-term rates rose above the 5% mark. As a result, the conversation on SCHW continues to revolve around interest rates. Because it's all about cash sorting challenges, isn't it?
The Fed's unprecedented rate hike regime has caused significant challenges with Schwab's transaction cash activity, as customers reallocated their funds to higher yield assets. As a result, Schwab took a substantial hit to its net interest revenue, or NIR, over the past year. In Q3 , Schwab's NIR fell 24% YoY, reflecting the extent of these challenges. It was much worse than the 10% decline in Q2'23. As a result, the market likely anticipated these headwinds, as Schwab reported its Q3 results in late October. With SCHW bottoming out over the same period, we can see how the market had already positioned for weakness heading into Schwab's third quarter earnings release.
The recent December update corroborates my bullish thesis in SCHW. It has also strengthened my conviction in Schwab's management confidence that the earnings growth and NIM headwinds should normalize by 2025. Accordingly, Schwab noted that the cash sorting headwinds have continued to ease. The company accentuated a " $5B increase in transactional sweep cash to $402.9B in November 2023, the largest monthly increase since March 2022." In addition, it also posted a 12% YoY increase in total client assets to $8.18T in November, strengthening its position as the leading integrated financial services company. However, if you wait for clarity as Schwab delivered its recent update, your risk/reward is no longer as attractive.
SCHW's forward adjusted EPS multiple of 20.6x has normalized toward its 10Y average of 21.3x. However, its FY25 adjusted P/E multiple of 14.4x suggests that the market hasn't fully reflected its earnings growth normalization. In other words, it's still too early for SCHW investors to cut exposure/take profits. Despite that, the surge from its October lows will likely face resistance at the current levels, although I don't expect SCHW to fall back toward its 2023 lows. As a result, I foresee a constructive consolidation zone, allowing some profit-taking to occur and possibly even a healthy pullback that could open up another solidly attractive opportunity to add more shares.
With my Buy thesis on The Charles Schwab Corporation stock having played out accordingly, as I ignored the doom and gloom, I'm ready to move to the sidelines at the current levels. I will wait for another chance to assess a more attractive opportunity to buy more. Otherwise, I'm happy with what I have and will continue to hold.
Rating: Downgraded to Hold.
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.
I Want To Hear From You
Have constructive commentary to improve our thesis? Spotted a critical gap in our view? Saw something important that we didn’t? Agree or disagree? Comment below with the aim of helping everyone in the community to learn better!
For further details see:
Charles Schwab: Offers An Invaluable Lesson To Outperforming (Downgrade)