Thursday Deep Dive: Charles Schwab
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This week Ryan, Ian, and I discussed Charles Schwab. Schwab is an investment services firm with over $6 trillion (yes, trillion) in assets under management (AUM). They have two flagship products: brokerage/retirement accounts and financial advisory services.
Its brokerage accounts are what an individual investor would use to buy and sell securities. Schwab makes money by investing idle cash in interest-bearing assets like treasuries or mortgage-backed-securities. It is the majority of their revenue at the moment, even with interest rates close to zero.
Advisory fees/services are a broad category that includes RIAs using them as a custodian, Robo-advisory services, and fees on ETFs and index funds.
In 1963 Chuck Schwab founded an investment advisory newsletter that 10 years later would morph into Charles Schwab & Co. After commission fees were deregulated on stock trades in 1975 Schwab continually lowered fees while the industry went in the opposite direction. Bank of America bought the company for $55 million in 1983, but four years later Chuck bought it back and took the company public.
Since its IPO, Schwab has continually lowered its commission fees on trading, eventually lowering them to zero in late 2018. The rest of the industry followed suit, and Schwab ended up buying out its competitor TD Ameritrade in an all-stock deal after TD’s stock declined 30%. It is considered one of the savviest business moves of the last decade.
Industry and Competition
Schwab competes with numerous other companies for retail brokerage services. The most notable competitors are Vanguard, Fidelity, and Robinhood, with many other small players. The two key metrics for the health of this business are growth in AUM and growth in the number of accounts. AUM growth directly correlates to the growth in interest revenue, and account additions correlate to future growth in AUM (especially if they are younger investors).
On the advisory services side, Schwab competes with any company that offers a platform for financial advisors as well as any other Robo-advisory service. The key indicators for this business are again the number of clients using Schwab and AUM. It should also be noted that Schwab makes money on ETFs and index funds, which are included in this revenue segment. Their largest competitors are Vanguard and Blackrock.
Schwab estimates there is around $44-$45 trillion in investable assets in the United States alone. Compare that to the $6 trillion in assets it will have post the TD acquisition and you can see they are a leader but not dominant in the industry.
Founder Charles Schwab is still the chairman of the board, and he was the CEO up until 2008. He still owns 7% of outstanding shares. Insiders as a whole own 10% of the company and the majority of all outstanding shares are held by institutions.
Chuck’s successor is Walter W. Bettinger II. He has been at Schwab since 1995 when his firm was acquired by them and has slowly worked his way into the CEO role. Outside of his name sounding like a 19th-century aristocrat, we found no red flags on Bettinger.
Valuation, Earnings, and Balance Sheet
Valuation (as of recording):
Market cap of $66.1 billion
LTM P/E of 18
Dividend yield of 1.81%
Total client assets of $4.4 trillion (will be $6 trillion at TD acquisition close)
Net revenue down 10% to $2.4 billion
Net income of $698 million, down 27% (lower interest rates + no commissions)
Large one-time costs this quarter with the TD acquisition
$34 billion in cash
$8 billion in LT debt
Trades at about 2x book value (an important metric for Schwab)
Does Charles Schwab Have any Competitive Advantages?
We all think Charles Schwab has clear competitive advantages in the form of switching costs and economies of scale. Other advantages were discussed as well:
Ryan chose diverse revenue streams vs. other brokers like eTrade. Since Schwab only made a small amount of money on commissions, they could rip the bandaid off without destroying a ton of their revenue.
Ian chose Schwab’s reputation for security and trust as an advantage over upstarts like Robinhood. We all agreed that people under 30 like to use Robinhood for small trades and options but move over to Schwab when they want to invest for real.
I chose the ability to offer Robo-advisory services for free, which gives them an advantage over Betterment and Wealthfront. Schwab doesn’t make money when someone signs-up but on the ETFs they buy and the idle cash that is put into money market funds.
What are Charles Schwab’ss Future Growth Opportunities?
Ryan chose security-focused marketing. What he meant by this is focusing on safety, long-term benefits for users, and education. This is opposed to the gamification tactics Robinhood employs to attract investors. Staying the course will increase the value of Schwab over the long-term because it will attract clients that will stick with the brokerage for the entirety of their adult lives.
Ian chose finding the right way to attract young investors. Schwab’s website looks like it is from 2007 and is difficult to use. Obviously, they shouldn’t trash everything and make it look like the Cash App or Robinhood, but bringing the functionality to 2020 would help new users navigate the site/app with ease.
I chose their Robo-advisory service. All you need is $5,000 to invest, and they set you up with a free account. It is a low margin business (they only make money on idle cash and tiny ETF fees), but one that can scale for a long-time.
What We Liked About Charles Schwab
We all agreed that the move by Bettinger to cut commissions and then buy TD on the cheap was fantastic. If you include that plus other moves Schwab has made over the past decade, we think the company is in great hands. Scale advantages and diversified revenue streams compared to their competitors were other positives. This stability, even in the face of zero percent interest rates, shows that Charles Schwab has a high floor as an investment (meaning the downside should be minimal) as long as they don’t start bleeding AUM.
What we Didn’t Like About Charles Schwab
One concern we had with Schwab, at least as an investment, is how interest rates control how profitable they are. This is something out of their control (and our control), so even if they make shrewd business decisions, the bottom-line might get worse.
We also thought Schwab has had trouble with innovation over the past decade. They’ve played catch-up to Robinhood for years, and seem to copy any good idea they have. A copycat strategy may work out, but it is a lowlight for the business nonetheless.
Links to Further Reading/Learning
Disclosure: The author is not a financial advisor, and may have an interest in the companies discussed.