VALUATION HIGHLIGHTS

1. Interest on Deposits, Loans & Securities constitute 55% of the Trefis price estimate for Charles Schwab's stock.
2. Asset Management Fees constitute 25% of the Trefis price estimate for Charles Schwab's stock.
3. Trading Commissions constitute 13% of the Trefis price estimate for Charles Schwab's stock.

WHAT HAS CHANGED?

Note: - Charles Schwab completed the acquisition of TD Ameritrade in early October 2020, creating a company with almost $8 trillion in client assets across 29 million brokerage accounts.

Latest Earnings

In Q3 2023, Charles Schwab reported Total Net Revenues of $4.6 billion - 16% lower than the year-ago period, mainly driven by a drop in net interest income and bank deposit account fees.

Charles Schwab acquired TD Ameritrade in Q4 2021. The Q4 results saw positive growth due to it. Further, the positive effect of the acquisition was also visible in the FY2021 results. Notably, FY2021 net revenues increased 58% y-o-y to $18.5 billion.

Below are key drivers of Schwab's value that present opportunities for upside or downside to the current Trefis price estimate:

Interest on Deposits, Loans & Securities

• Net Interest Income Rate on Deposits, Loans and Securities Analysis: Schwab's structure ties its income to market interest rates. As a result of the low-interest-rate environment, net interest rates decreased to 1.63% in 2020. However, it increased to 1.80% in 2022 due to interest rate hikes by the Fed. We forecast this yield to reach around 2.15% by the end of the Trefis forecast period. However, if the interest rate rises to about 2.40% during the same timeframe, there would be a upside of around 6% to our price estimate


• Interest Earning Deposits, Loans and Securities : Schwab's interest-earning assets have been growing significantly in the last few years, reaching over $375.7 billion in 2020. This metric grew further to about $593.8 billion in 2022. We currently forecast these assets to grow steadily through the end of the Trefis forecast period, eventually approaching $1 trillion. Notably, acquisition of TD Ameritrade in 2020 is the main reason behind the jump in the numbers. However, should the growth be slower than expected - due to intense competition and any further need to deleverage the balance sheet - and these assets remain around $835 billion, in the long run, there would be a potential downside of 10% to our price estimate.

BUSINESS SUMMARY

Charles Schwab is an brokerage firm that allows clients to buy and trade equities, options, and other securities in the market. Charles Schwab also offers money management services to its clients. Schwab charges clients a certain percentage of assets invested as a fee. Clients can invest money in Charles Schwab Proprietary Funds, Schwab Fund, and Laudus Fund or use Charles Schwab OneSource Mutual Fund Services to invest in a select list of third-party mutual funds.

SOURCES OF VALUE

While revenues from trading commissions have continued to decrease over the years, interest income on deposits, loans & securities has increased since 2010, on the back of substantially higher interest-earning assets and improved interest rates.

We expect that net interest income will continue its solid growth over the Trefis forecast period on the back of continued growth in interest-earning assets and interest rates hikes in the future.

Higher net interest yield going forward

Charles Schwab earns interest on client assets awaiting investment by placing those assets into money market instruments. Schwab's investments are funded by brokerage and banking clients, and Charles Schwab, in return, pays interest to the clients. The net amount is the net interest revenue for Schwab.

In 2017, Charles Schwab earned about a 1.97% net interest yield on nearly $218 billion of client assets. In 2018, the company earned about 2.31% net interest yield on nearly $252 billion of client assets. That said, the yield decreased in 2020 to 1.63%, although the client assets increased to $375.7 billion. However, the Federal Reserve initiated the rate hike process in 2022, leading to a net interest yield of 1.8%. We expect the net interest yield to be around 2.15% over our forecast period.

Asset management becoming increasingly valuable

Asset and investment management are becoming of growing part of the brokerage. However, competition in asset management is also growing due to the prevalence of low-cost ETFs that serve as an alternative to managed investment funds and digital advisory. While Schwab is a leader in the ETF space, it has gotten increasingly competitive.

Low mutual fund fees

Clients can invest money in Charles Schwab's proprietary funds, Schwab Fund and Laudus Fund, or use Charles Schwab OneSource Mutual Fund Services to invest in a select list of third party mutual funds. Schwab earns a management fee for these services.

Although Schwab's assets under management are much higher than the client assets on which it earns a net interest spread, Schwab earns a fee of only 0.163% of managed assets (as per 2022), which is low compared to the yield the company has traditionally earned on client assets. As a result of this difference, net interest on deposits, loans, and securities is a more valuable business for Schwab than mutual fund & investment fees.

KEY TRENDS

Declining trading commissions

With more than 33.75 million active brokerage accounts, Schwab is one of the leading online brokerage firms. Schwab's revenue per trade has been declining in recent years and stood at about $2.47 per trade in 2022. With stiff competition in the market and a lot of brokerage firms offering free trading, we forecast the commissions to decline in the near term.