Why Charles Schwab Looks Like A Better Bet Than Intercontinental Exchange

by Trefis Team
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Charles Schwab’s stock (NYSE: SCHW) has dropped by roughly 5% since the beginning of 2018. On the other hand, Intercontinental Exchange’s stock (NYSE: ICE) has gained around 35% during the same period. This, despite the fact that Charles Schwab’s revenue growth for the 2017-2019 period stood at 24%, compared to just 12% for ICE. Does that make sense? We don’t think it does and believe Charles Schwab is likely a better investment right now.

Our dashboard ‘Charles Schwab vs. Intercontinental Exchange: Does The Stock Price Movement Make Sense?’, has the underlying numbers.

Similar to revenues, Charles Schwab’s profit margins (adjusted net income as a percentage of sales), are higher at 32.9% versus 29.5% for Intercontinental Exchange. Further, ICE’s profit margin has reduced over the last three years – from 43.2% in 2017 to 29.5% in 2019, whereas Charles Schwab’s figure has improved from 25.3% to 32.9%, creating a significant difference in the profitability aspects of the two companies. This further strengthens our argument that the company fundamentals don’t explain the growth in ICE’s stock when compared to Charles Schwab – with ICE’s P/E multiple looking inflated at 28.4x based on its current market price and FY’19 EPS while the figure for Charles Schwab is 13.6x.

How Do The Core Businesses For Charles Schwab And Intercontinental Exchange Compare?

Let’s look at the core business prospects a bit more closely. Charles Schwab is a brokerage giant that generated around 91% of its revenues in 2019 from asset management fees and interest on deposits, loans & securities. As a result of high volatility in the securities markets, both these revenues streams are likely to struggle in the near term due to lower asset valuations driven by net market losses. Further, the company charges commissions from its customers on a per-trade basis. While the company has witnessed a spike in daily average trades since February (which implies higher trading activity in the stock market), the elimination of most of the trading commissions late last year means that Schwab’s revenues aren’t going to derive significant benefit from this. On the flip side, its strong customer base and significant brokerage assets will enable it to drive growth post the Covid-19 crisis – especially because the acquisition of TD Ameritrade will further boost its asset and customer base. More information about Charles Schwab’s revenues forecast over FY 2020-21 is available in our interactive dashboard.

On the other hand, Intercontinental Exchange, which owns exchanges for financial and commodity markets, derives around 62% of its revenues from transaction and clearing services. As the revenue is generated on a per-transaction basis, high trading activity in the securities markets due to ongoing coronavirus pandemic and economic uncertainty is likely to benefit Intercontinental Exchange’s revenues. Further, the company also provides data services, which is likely to see more demand due to higher trading activity. Overall, despite the current crisis, ICE is likely to witness positive revenue growth in FY 2020.

That said, while ICE looks more immune with its focus on financial exchanges, Charles Schwab’s isn’t far behind. In fact, with a large customer base and substantial brokerage assets, it could recover the lost ground in a short period of time post the Covid-19 crisis. Further, as the securities markets move towards recovery, the asset valuations will also improve. This provides a promising floor to our belief of Charles Schwab being undervalued versus Intercontinental Exchange.

To distill, we believe Charles Schwab’s stock is likely to outperform Intercontinental Exchange’s stock, if not near-term, at least in the medium- to long-run.

There may be an even bigger opportunity when you compare Discover Financial to Mastercard.

 

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