In this article, let's take a look at this brokerage firm and try to explain to investors the reasons this is an apparently appealing investment opportunity.
The company provides financial services to individuals and institutional clients through two segments: Investor Services and Institutional Services. The Investor Services segment provides retail brokerage and banking services to individual investors. The Institutional Services segment provides custodial, trading, and support services to independent investment advisors. The Institutional Services segment also provides retirement plan services, specialty brokerage services, and mutual fund clearing services. The company seeks to meet the financial services needs of investors, advisers and employers. It focuses on building client loyalty with the goal of attracting new clients and serving them. Additionally, Schwab´s strengths through shared core processes and technology advances which help create services that are scalable and consistent with the business.
Interest Rates, Capital Structure and Debt-to-Capital Ratio
The results are dependent on short-term interest rates, as 37% of its top line came from net interest income in the first quarter of 2014.The broker has been making significant efforts to become less dependent on interest rates, which we expect Federal Reserve will raise them in late 2014 or 2015. Also, the company´s plan is to reach a low-cost capital structure and targets a long-term debt-to-total financial capital ratio of less than 30%.
Lucrative Derivatives Trading
In 2011, the company acquired Compliance11 Inc. and optionsXpress Holdings Inc., a leader in options and futures trading. The optionsXpress deal expands its options and futures reach, adding the retail options brokerage. This also has an impact on the company´s registered investment advisor (RIA) business. Schwab has completed a lot of takeovers since 1999, according to data compiled by Bloomberg.
The firm is currently Zacks Rank # 2 – Buy, and it also has a longer-term recommendation of “Neutral”. A Buy rating indicates that the stock, over the next 1 to 3 months, will perform at an annualized rate of 19.04%, which we think is very attractive. For investors looking for a Zacks Rank# 1–Strong Buy, Interactive Brokers Group, Inc. (IBKR), Investment Technology Group Inc. (ITG) and Piper Jaffray Companies (PJC) could be better options.
Relative Valuation, Earnings and ROE
In terms of valuation, the stock sells at a trailing P/E of 35.3x, trading at a premium compared to the industry mean. Due to its revenue growth, Earnings per share (EPS) have increased in a by 60%in the most recent quarter compared to the same quarter a year ago. In the next graph we include the stock price because EPS often lead the stock price movement. As we can appreciate in the chart, the price performance was really good in the past year.
Finally, I always like to see one of the most important financial ratios applying to stockholders, the best measure of performance for a firm's management: the return on equity. The ratio has increased from the same quarter one year prior. This is a clear sign of strength within the company.
Let´s compare the current ratio with the peer group in the next table:
Interactive Brokers Group, Inc
Investment Technology Group Inc.
Piper Jaffray Companies
TD Ameritrade Holding Corporation
E*TRADE Financial Corporation
Arlington Asset Investment Corp.
Charles Schwab has a current ratio of 10.32% which is higher than the ones registered by Interactive Brokers Group, Inc., Investment Technology Group Inc., Piper Jaffray Companies, E*TRADE Financial Corporation (ETFC) and Arlington Asset Investment Corp. (AI). For investors looking for a higher ROE, TD Ameritrade Holding Corporation (AMTD) is a good option.
As outlined in this article, we think Schwab should be a good fit in investor´s portfolios. We expect the recent move to a flat commission schedule and free trades for many of its ETFs will sustain revenues’ growth.
I would recommend investors to consider adding the stock for their long-term portfolios. Hedge fund gurus have also been active in the company in the fourth quarter of 2013. Gurus like Murray Stahl (Trades, Portfolio), Jeremy Grantham (Trades, Portfolio), Arnold Van Den Berg (Trades, Portfolio), Pioneer Investments (Trades, Portfolio), Jim Chanos (Trades, Portfolio) and Frank Sands (Trades, Portfolio) have taken long positions on it.
Disclosure: Victor Selva holds no position in any stocks mentioned.
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