Charles Schwab SCHW recently reported results for the third quarter of fiscal 2019.
During the quarter, net revenues increased 5% to $2.7 billion. Growth was primarily attributable to a 7% increase in net interest revenue to $1.63 billion. This reflects a slight improvement in yield (up 10 basis points year-over-year to 2.43%), as well as continued growth in client cash allocations. The remainder of the business was relatively unchanged, with asset management and administration fees up 2% and trading down 2%.
Growth in active brokerage accounts and total client assets continued, with both up 6% in the quarter (to $12.1 million and $3.8 trillion). The latter was supported by a mid-single-digit increase in core net new assets, with net market gains and losses being a wash over the past year. As CEO Walt Bettinger noted on a conference call, “Investors continue to reward us with strong business growth. Our contemporary full-service model helps us remain a trusted partner as clients navigate an environment that has only grown cloudier in recent months.”
As shown below, client assets have consistently marched higher over the past decade, with a compounded annual growth rate of roughly 10% (with help from rising equity markets).
In addition to core business growth, Schwab is increasingly providing higher value services to clients. In the quarter, assets receiving ongoing advisory services climbed 7% to $2 trillion, with assets in digital advisory solutions (like Intelligent Portfolios) up 20% to $43 billion.
Expenses in the quarter increased 8%, with roughly half of that growth attributable to severance costs (Schwab eliminated positions covering roughly 3% of its workforce in the quarter). This outsized expense growth led to a slight degradation in pre-tax profit margins (down 170 basis points to 45.6%), with net income climbing 3% year over year to $951 million. After accounting for a 4% reduction in the diluted share count, earnings per share increased 8% to 70 cents per share (if you back out the severance costs, earnings per share increased by roughly 14%). Year to date, revenues, net income and earnings per share have increased 9%, 11% and 15%.
As has been widely discussed in the financial press, Schwab recently decided to eliminate online trading commissions for stocks, exchange-traded funds and options in the U.S. and Canada. In a note to shareholders, Chief Financial Officer Peter Crawford estimated that this will result in a $90 million to $100 million reduction in quarterly revenues, which translates to a low-single-digit percentage of Schwab’s total revenues. In his commentary, he also touched on the strategic rationale for this decision:
“It’s the right move from a competitive standpoint. There has been a clear pause in the so-called commission wars among the “traditional” e-brokers since the price reductions we made in 2017. At the same time, we are seeing new firms trying to enter our market – using zero or low equity commissions as a lever. We’re not feeling competitive pressure from these firms… yet. But we don’t want to fall into the trap that a myriad of other firms in a variety of industries have fallen into and wait too long to respond to new entrants. It has seemed inevitable that commissions would head towards zero, so why wait? We have a business model that doesn’t depend on commission revenue, a long-term orientation and a history of being willing to disrupt ourselves based on client needs and competitive dynamics. That’s exactly what we are doing here - we’re making these pricing changes because we believe they enhance both our value proposition and our competitive positioning, encouraging the consolidation of client assets and trades at Schwab.”
Personally, I think he makes a compelling point. Trading, which accounted for 60% of Schwab’s revenues 20 years ago (when the commission rate was at roughly $30 per trade), has become immaterial to the company’s financials. At the same time, it remains important to its traditional competitors and has been a selling point for some new entrants. For that reason, I can appreciate the strategic rationale for waking up one morning and deciding to walk away from a few hundred million dollars in annual revenues. (With that said, I think the idea that taking the cost of a trade from $4.95 to zero will make investing “accessible to all” is rubbish – and potentially a negative in terms of the long-term investment results that will be achieved by the average individual.)
Conclusion
A glance at the key metrics shows that Schwab has performed well over the past five to 10 years. Personally, I have been most impressed by its consistent core net new asset growth.
Looking ahead, I believe Schwab will continue to gather assets and take share. While the business faces headwinds in the current interest rate environment, I think that’s a manageable issue for long-term investors. I don’t currently own the stock, but I could see that changing in the near future.
Disclosure: None
Read more here:
- Some Thoughts on Fastenal
- Union Pacific: Operating Efficiently in a Tough Environment
- Wells Fargo: Navigating a Difficult Rate Environment
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