2023-04-14 08:30:09 ET
Summary
- Charles Schwab is due to release its first-quarter 2023 earnings report on Monday.
- Based on our analysis and Wall Street's guidance, the company will likely reveal mixed results.
- Schwab's debt portfolio probably stabilized during Q1 after significant impairments in 2022.
- The firm's sell-side trading activities remain in decline.
- SCHW stock's elevated price-to-book multiple is a severe concern as slowing growth, a goodwill build-up, and recent impairment losses provide structural problems.
Charles Schwab Corporation ( SCHW ) is set to release its first-quarter earnings report before the market opens on Monday, the 17th. Schwab's Q1 report has been highly awaited amid fears of a severe decline in earnings. Astonishingly, 14 analysts have revised their earnings outlook downward since the company's previous release in January.
It is expected that Schwab will deliver an earnings-per-share figure worth $0.82 in Q1, a significant decline from its previous $0.97. After discovering the series of downward revisions, we decided to weigh in on it all; here is what we think investors should look out for ahead of Schwab's Q1 release.
Massive Change in Charles Schwab's Asset Base
The most influential factor to consider ahead of Schwab's Q1 earnings release is its recent asset base adjustment. During 2022, Schwab shifted approximately $188.55 million in available-for-sale securities to its held-to-maturity account. It is believed that the restatement was due to management's opinion that much of the firm's AFS debt securities were impaired by carrying values below their amortized values, which required a restatement. In our view, this can be considered a credit event in many ways, as such a significant debt asset reclassification is exceptionally scarce.
Due to the failed AFS impairment test and subsequent reclassification, Schwab recorded a loss of approximately $18.228 million, which is obviously a setback. However, there is a good side to all of this as well. Unrealized gains and losses on HTM securities are not recorded in a firm's income statement; instead, their values are amortized on a firm's balance sheet while their net interest income still reflects on the income statement. Therefore, in isolation, Schwab's reclassification could lead to an improved net income result in its Q1 report, especially considering how supportive interest rates have recently been to income-generating debt securities.
In our view, the rest of Schwab's asset base might have performed strongly in Q1. As mentioned before, interest rates have remained supportive going into 2023. Although the systemic shock from the SVB Financial Group's ( SIVBQ ) crash might have increased Schwab's cost of funding, its loan portfolio likely produced a net profit in Q1. Additionally, considering the year-to-date rally in both the stock and bonds market , we believe that Schwab's margin loan results will turn in favorably on Monday.
Trading Remains Slow
Despite the string of events relating to Schwab's interest-bearing activities, its trading and commissions division has remained flat. Although the firm last posted data in February, it can be inferred that 2023's financial market recovery is yet to trigger renewed demand for brokerage demand.
For the sake of exposition, I would like to reference the fact that Schwab's February stats revealed that new brokerage accounts suffered an additional 7% month-over-month decline. Will we see a recovery of Schwab's sell-side trading segment? In our opinion, the ongoing financial market recovery will definitely result in a segmental rebound; however, that rebound is unlikely to reflect in Schwab's Q1 report.
Furthermore, as of February this year, Schwab's year-over-year investor and advisory services growth rates retreated by 2% and 3%, respectively. Advisory and investor services are generally considered the least volatile components of a financial institution's revenue mix; therefore, we do not expect these business units to have acted as key influencing factors during Q1.
Schwab's Past Earnings Misses
Although a simple observation, past earnings performance provides a key indicator of future earnings performance. In fact, seminal research suggests that earnings momentum is more prevalent than most believe.
Schwab has a history of missing out on its bottom line, which diminishes our confidence that the firm will produce positive results on Monday. Moreover, another earnings miss could add pressure to the company's stock price, regardless of Schwab's operational outlook.
SCHW Stock Valuation Debated
Charles Schwab's book value per share is pivotal as it is a financial entity with an asset base consisting of quoted and liquid assets. Therefore, the company's book value provides a strong indication of its stock's fair market value.
Based on its retrospective data, Schwab's stock is trading at 3.55 times its book value. Investors have pardoned its historically high book value premium due to the company's robust organic growth rates; however, an interim slowdown in trading-based activities and its impairment of AFS securities might cause the firm's growth to stagnate. Moreover, due to its historical premiums on acquisitions, Schwab's book value contains approximately $12 million in goodwill, meaning its tangible book value is possibly worth less than its baseline book value.
Although Schwab pays a dividend with a 5-year average yield on cost of 1.74% , we deem this stock overvalued with little total return prospects.
Final Word
Based on our analysis, Schwab's first-quarter earnings report will likely show mixed results. Even though we think its debt portfolio has recovered from impairment losses in 2022, the firm's trading activities remain stale. In our view, the latter will proliferate during the course of the year; however, it is unlikely that a significant recovery will reflect in Schwab's Q1 report.
Furthermore, slowing growth, recent impairments, and gradually increasing goodwill mean that Schwab stock's price-to-book premium is becoming a risk worth considering. Additionally, the firm's dividend probably does not yield enough substance to phase out its stock's price risk.
In essence, we urge investors to be careful ahead of Schwab's first-quarter earnings release on Monday.
For further details see:
Charles Schwab Q1 Earnings Preview: Volatility En Route