2023-04-17 10:30:34 ET
Summary
- The Charles Schwab Corporation reported strong results for the first quarter.
- The company beat profit estimates and showed excellent profit growth.
- The Charles Schwab Corporation shares are cheap and could deliver compelling total returns.
Article Thesis
The Charles Schwab Corporation ( SCHW ) reported its first-quarter earnings results , easily beating profit estimates. Organic growth was healthy, and it does not look like the company is facing existential troubles at all. Since shares have declined considerably so far in 2023, the company could be an attractive long-term investment at current prices.
What Happened?
The Charles Schwab Corporation reported its most recent quarterly earnings results, for its fiscal first quarter , on Monday morning. The company's top-line and bottom-line results can be seen in this screencap from Seeking Alpha:
The company beat profit estimates easily, although it missed revenue estimates marginally. The 9.6% year-over-year increase in Schwab's revenues was slightly below the forecasted 9.8% rise, but I do not see this as dramatic at all. Importantly, the year-over-year growth was very healthy, despite the small miss versus the consensus estimate. Charles Schwab Corporation being able to deliver revenue growth of almost 10% is also compelling versus what some investors had been expecting based on a rather weak sentiment when it comes to SCHW stock in the recent past.
Healthy Underlying Results
While Charles Schwab Corporation is not a bank, the financial services company still saw its shares come under a lot of pressure during the banking crisis and bank stock sell-off that was caused by the collapse of Silicon Valley Bank of SVB Financial Group ( SIVBQ ), Credit Suisse Group AG (CS), and so on.
Today, SCHW trades at $50 per share (pre-market price at the time of writing), which is at the low end of the $45 to $87 trading range for Schwab's shares over the last year. In 2023 alone, SCHW experienced a share price decline of almost 40%. But this share price decline was largely driven by investor fears and an unwillingness to own financial corporations.
This price decline was largely driven by fears, however, and not by underlying results. Those were, at least during the first quarter of the current year, pretty solid, I believe. The company's management sees things the same way. As the company's CEO and Co-Chairman Walt Bettinger explains (emphasis added by author):
"While equity markets rebounded from year-end 2022 levels, investor sentiment remained bearish - especially following the onset of the banking industry turmoil in early March. Fixed income markets also reflected growing fears of an economic downturn as the 10-year U.S. Treasury yield declined approximately 50 basis points from its intra-quarter peak to end March just under 3.50%. Through the various ups and downs to start the year, Schwab remained a trusted partner to investors. During the quarter, clients opened over 1 million new brokerage accounts and entrusted us with $132 billion of core net new assets - including over $53 billion in March alone. While Investor Services gathered approximately $60 billion during the period, the Advisor Services segment posted a record first quarter with over $71 billion in net flows and attracted 70 transitioning advisor teams. These near-record inflows across both our primary businesses represent an annualized organic growth rate north of 7% and helped push total client assets to $7.58 trillion at quarter-end ."
If the company had held its level of client assets at a constant or unchanged level, that would have been a solid result, considering its shares slumped massively in the recent past. But that was not the case, as Schwab actually generated quite compelling business growth. Things look positive across many important operational metrics:
- The company added new customers at a substantial pace, which indicates that potential customers are not scared about potential liquidity issues. Instead, (potential) customers seem to see Charles Schwab Corporation as a trustworthy, low-risk business partner.
- The company added new assets at a massive pace, with inflows almost at the highest level seen in SCHW's history. Considering the macro environment of high uncertainties, recession fears, and so on, that is, I believe, a great result.
- Client asset growth was very healthy, at more than 7%, which indicates that the company should not have major problems in growing its sales over time. When SCHW is able to grow its client assets at a substantial pace even during times like these, when investor fears are high, then SCHW should be able to grow its assets throughout a cycle as well, especially during better times when investors are less fearful.
- Last but not least, SCH's customers seem to be happy with how the company is operating. CEO Bettinger stated: " It was an honor to be ranked #1 in Investor Satisfaction with Full-Service Wealth Management Firms by J.D. Power. " (see Seeking Alpha report linked above). Since customer satisfaction is essential for keeping customers from switching to competitors, and since high customer satisfaction can also be a tailwind in getting new customers, this bodes well for SCHW's success in the future, I believe.
But business growth is not the only positive in SCHW's results, as the company also performed well on the cost side and when it comes to returning cash to the company's owners.
Charles Schwab Corporation saw its pre-tax profit margin expand by more than 100 base points, both when it comes to reported ((GAAP)) results, as well as when it comes to adjusted (non-GAAP) results. This was the result of a combination of substantial revenue growth and tight cost controls - despite the current high-inflation environment, SCHW made sure that its expenses did not grow too much, which is a notable and very positive fact, as many other companies have been battling vast expense growth and margin pressure in recent quarters. As a result, SCHW's operating margin expanded to a very attractive level of 46%. Whether the company will be able to grow its margins further going forward is not certain, but due to operating leverage that seems at least possible, as long as SCHW continues to experience solid business growth and as long as cost controls remain tight.
The revenue gain and the margin tailwinds allowed Charles Schwab Corporation to grow its net profit by an already attractive 12% year over year, but SCHW's earnings per share growth was way more attractive still, as earnings per share rose by 21% compared to the previous year's quarter. The substantial difference between these two growth rates can be explained by the fact that SCHW has bought back shares at a substantial pace over the last year, with its share count dropping from more than 1.9 billion to just 1.84 billion during the first quarter. With SCHW trading at an undemanding valuation today, it would make sense if management decided to use this opportunity to reduce the share count aggressively.
Valuation And Potential
While nobody can predict share price movements in the near term, I believe that there is a good chance that SCHW will deliver substantial returns in the long run.
Today, Charles Schwab Corporation trades at 13.5x forward earnings. And since SCHW has beaten earnings per share estimates for the first quarter, the full-year estimates may very well turn out to be too conservative as well -- in this case, the valuation would be even lower. But assuming that EPS estimates are correct, SCHW still seems pretty inexpensive. The 10-year median earnings multiple stands at 28, according to YCharts, and the 5-year median earnings multiple stands at 23. While I do not believe that SCHW should trade at more than 20x net profits, as the interest rate environment today is different from 5 or 10 years ago, it would not be overly bullish to see Schwab's valuation expand to a 15x - 18x earnings multiple over the next couple of years. That could add meaningfully to its total returns while underlying profit growth should be a total return driver as well. Add a dividend yield of 2%, which is slightly more than the broad market's yield, and Charles Schwab Corporation could be a quite attractive total return play going forward, I believe.
The strong results from SCHW during the first quarter, both on an operational basis (e.g., net inflows) and when it comes to margins and profits, make me believe that SCHW is underpriced today and that shares are attractive.
For further details see:
Charles Schwab: Strong Results Blow Up Bear Thesis