Is Charles Schwab Stock Undervalued?
[Updated 08/16/2021] Charles Schwab Update
Charles Schwab stock (NYSE: SCHW) has gained 42% YTD, and at its current price of $74 per share, it is almost 10% below its fair value of $82 – Trefis’ estimate for Charles Schwab’s valuation. The brokerage giant recently released its second-quarter 2021 results, with revenues and earnings beating the consensus estimates. It reported net revenues of $4.5 billion – 85% more than the year-ago period, mainly driven by a 40% growth in net interest income coupled with a 4x jump in trading revenues. Further, asset management and administration fees recorded a 31% y-o-y growth in the quarter. Notably, the firm completed the acquisition of TD Ameritrade in October 2020, which is the main reason behind the spike in revenues.
The company’s revenues of $11.7 billion in 2020 were 9% higher than the 2019 figure. The growth was primarily achieved in the fourth quarter due to the TD Ameritrade acquisition. Further, SCHW reported a revenue growth of 80% y-o-y in its first quarter of 2021, primarily driven by higher net interest income (NII) and trading revenues. The same trend continued in the second quarter of 2021 also. Notably, Charles Schwab’s interest-earning assets grew 41% between December 2020 and June 2021 to $531 billion. Further, its total client assets increased 13% to $7.6 trillion over the same period. Moving forward, we expect the NII to further improve in the year driven by asset growth partially offset by a lower interest rate environment. Further, the unusually higher trading volumes are likely to normalize with improvement in the economy, though it will take some time. Overall, we expect Charles Schwab’s revenues to touch $18.3 billion in FY2021 – 56% more than the 2020 figure. Additionally, the company’s adjusted net income margin is likely to see some improvement in 2021. This paired with the higher revenues will likely result in an adjusted net income of $4.9 billion – up approximately 60% y-o-y. This will increase the EPS figure to $3.48, which coupled with a P/E multiple of just below 24x, will lead to the valuation of $82.
[Updated 06/25/2021] Charles Schwab Stock Has Limited Upside
Charles Schwab stock (NYSE: SCHW), the largest brokerage firm in the U.S., gained roughly 37% – increasing from about $53 at the beginning of 2021 to around $73 currently, outperforming the S&P500, which grew 13% over the same period. The brokerage giant has surpassed the consensus estimates over the last two quarters, mainly driven by considerable growth in total client assets and brokerage accounts. Further, the company has seen a significant surge in new clients and daily trading activity over the recent months. This has led to positive investor interest in the stock.
There were two main reasons for this growth: First, the approval of the $1.9 trillion stimulus package. Second, increased retail investor participation.
But is this all there is to the story?
Not quite, despite the recent gains, Trefis estimates Charles Schwab’s valuation to be around $76 per share – slightly above the current market price, based on a key opportunity and one risk factor.
The opportunity we see is an improved trajectory for Charles Schwab’s revenues over the subsequent quarters. The company reported $11.7 billion in revenues for the full year 2020, which is 9% ahead of the 2019 figure. All of this growth was derived in the fourth quarter of 2020, where the company posted a 60% y-o-y increase in revenues. It was due to the completion of the TD Ameritrade acquisition at the start of October 2020, creating a brokerage behemoth. SCHW trading revenues benefited from higher trading activity in the market and increased retail investor participation. Further, its asset management revenues grew 8% y-o-y driven by higher Assets under Management (AuM) – AuM increased 11% y-o-y to $1.97 trillion. That said, this was partially offset by a 6% y-o-y drop in its net interest income (NII) due to the lower interest rate environment.
The company reported significant growth in the first quarter FY2021 – net revenues jumped 80% y-o-y to $4.7 billion. The increase was mainly due to 22% growth in NII coupled with a more than 5x jump in trading revenues. While the NII primarily benefited from higher interest-earning assets as a result of the TD Ameritrade acquisition, partially offset by interest rate headwinds, trading revenues gained from an increase in daily average trades to 8.4 million. On the flip side, trading volumes are expected to normalize with recovery in the economy. But it is likely to take some time. Overall, we expect the SCHW revenues to touch $18.1 billion in FY2021 – 55% more than the 2020 figure.
The adjusted net income margin is likely to see some improvement in the year due to higher revenue growth. As a result, the company’s net income is likely to grow 69% y-o-y to $5.1 billion, leading to an EPS of $3.66. The EPS of $3.66, coupled with the P/E multiple of just below 21x will lead to a valuation of around $76.
Finally, how much should the market pay per dollar of Charles Schwab’s earnings? Well, to earn close to $3.66 per year from a bank, you’d have to deposit about $366 in a savings account today, so about 100x the desired earnings. At SCHW’s current share price of roughly $73, we are talking about a P/E multiple of around 20x. And we think a figure closer to 21x will be appropriate.
That said, brokerage and asset management is still a risky proposition. While growth is likely, change in current market sentiment can harm the near-term outlook. What’s behind that?
Securities markets have seen a spike in trading volumes over the recent quarters. It is also evident from the significant increase in SCHW’s daily trading volume in the first quarter of FY2021. This spike was mainly driven by higher retail investor participation in the market – the company added 3.2 million new brokerage accounts in the quarter. While retail investor participation has significantly increased, it is also to be noted that they don’t have much loss-taking capacity. Hence, a sudden course correction in the market can result in considerable losses for them, pushing them out of business, and hurting the company’s top-line. Additionally, any further deterioration in the economy can lead to a drop in asset valuations, negatively impacting the asset management revenues. To sum things up, we believe that Charles Schwab stock is slightly undervalued.
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