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Charles Schwab (NYSE:SCHW) is scheduled to report its earnings for Q4 2013 on January 16. Last quarter, it reported year-on-year revenue growth of 15%, driven by growth across all its major business segments – asset management fees grew 11%, while net interest revenue and trading revenue grew by 15% and 10% respectively. Growth in asset management fees and net interest revenue was primarily driven by an increase in assets, while trading revenue benefited from the gradual improvement in trading levels. We expect this trend to continue in the upcoming earnings release as Schwab has continued to add more client accounts and assets, and overall daily trading volumes have remained above the 450,000 mark. The recent start of QE tapering by the Federal Reserve is another tailwind for Schwab’s net interest income.
Although we remain optimistic about Schwab’s future, our price estimate for the company stock is around $20, which is at a discount of almost 20% from the current market price. We believe the company would need to grow its client base and margins at a significantly higher rate than our projections over the next few years in order to justify its current market price.
Schwab Continues To Attract Clients, Assets
Charles Schwab has been attracting client accounts and assets at a rapid pace over the past few years, and the trend seems to have continued in Q4 2013 as well. It opened 81,000 and 76,000 new brokerage accounts in October and November respectively, and the total number of active brokerage accounts on its platforms reached a record high of 9.1 million at the end of November. The company’s client assets also reached an all-time high of around $2.2 trillion at the end of November, driven by continued client inflows and market action. We currently forecast the number of active brokerage accounts on Schwab’s platform to increase at a rapid pace over the next few years, and reach almost 11.4 million in 2020 from around 9.1 million currently. Its total client assets are expected to double by the end of this decade from around $2.2 trillion currently.
The increase in brokerage accounts is a positive for Schwab’s trading commissions business, which has been struggling with low trading volumes for a few years now. As more clients open new accounts, the total trading volume on Schwab’s platform is likely to increase, even though the average number of trades executed by a typical client remains subdued. Overall trading volume depends on the total number of brokerage accounts, as well as the average number of trades executed per account annually.
Similarly, an increase in asset base is likely to benefit asset-based revenue streams such as net interest income and asset management fees. Over the past few years, Schwab’s net interest income has been negatively impacted by the low interest rate environment, but a healthy increase in overall asset levels continues to act as a cushion. Low interest rates put downward pressure on the spread earned by the brokerage on its client assets. The spread earned by Schwab on its interest earning assets declined from 2.13% in 2009 to just around 1.62% in 2012, and is likely to remain suppressed until interest rate remain low. However, going forward we do not expect a significant decline in this figure, given that the Fed has already started tapering its QE program.