Charles Schwab Stock: A Solid Value Play (NYSE:SCHW)

Charles Schwab (NYSE:SCHW) submitted a decent results sheet for Q4’23 on Wednesday that despite lower earnings beat expectations on the bottom line. Charles Schwab’s shares skidded 6% after the news, but recovered towards the end of the day, indicating that investors may have read the report too negatively. I believe that Charles Schwab continues to be an interesting brokerage play, especially because of the Federal Reserve’s decision to lower interest rates.

Charles Schwab has suffered from major cash-sorting efforts on the part of its clients last year, as investors reacted to better-yielding investment options in the market for money market funds. Since shares of Charles Schwab are trading close to my fair value estimate of $60, I continue to rate SCHW as a buy after Q4’23 results!

Previous rating

Charles Schwab was a strong buy for me in the $50-55 price range last year and I most recently (October 2023) called the brokerage company a deep value opportunity when the price dipped below $50. The brokerage’s Q4’23 results prove that Charles Schwab is a very profitable financial services franchise that achieved double-digit profit margins, despite earnings headwinds. Following Q4’23 earnings, I confirm my buy rating on shares of Charles Schwab.

Strong core profitability despite earnings headwinds

While Charles Schwab has seen a decline in its earnings in Q4’23, the financial services firm reported earnings that came in higher than expected: Charles Schwab disclosed earnings for the fourth-quarter of $0.68 per-share, which beat estimates by $0.04 per-share. Revenues, however, came in slightly lower than expected at $4.46B (missing the average prediction by $35M).

Although Charles Schwab’s earnings declined 36% year over year in Q4’23, but the brokerage remained widely profitable regardless and achieved $1.37B in earnings. Charles Schwab’s profit margin was a healthy 26.8% (36.0% on an adjusted basis) as the financial services company benefited from strong client activity and also managed to grow its core net new assets throughout the fourth-quarter consistently.

Massive core net new assets inflows, including in December 2023

Charles Schwab’s long term strategy is to grow its net new assets by 5-7% annually, which broadly falls in-line with its historical average. In FY 2023, the financial services firm added a massive $306B in core net new assets to its platform, showing an annual growth rate of 6%. In December alone, Charles Schwab’s core net new assets grew $43.1B which implies that investors continue to trust Charles Schwab as a destination for their capital.

Cash-sorting behavior is set to reverse

Charles Schwab has suffered from higher interest rates in so far as clients have reduced their bank balances and moved funds into higher-yielding money market funds, thereby negatively impacting Charles Schwab near term earnings prospects. This trend started back in 2022 when the market began to expect the Federal Reserve to adopt a much more aggressive attitude towards interest rate increases in a high-inflation world.

According to the latest Supplementary Monthly Report, Charles Schwab continued to see pressure on its bank deposits and funds continued to flow into higher-yielding money market funds. In December, the financial services company continued to attract new capital into money market funds which swelled Schwab’s total capital invested in those funds to $477.4B, showing an increase of 69% over the year-earlier period. Over the next twelve months, I expect these asset flows to reverse.

Charles Schwab is a value stock

The last time I worked on Charles Schwab, I lowered my fair value estimate from $70 to $60. But Charles Schwab continues to deliver solid earnings and margins and competition in the market is limited to just a small number of major brokerage service companies, such as Charles Schwab or Interactive Brokers Group (IBKR). Analysts expect Charles Schwab to generate $4.62 per-share in earnings next year and estimates are rising.

Given the strength and profitability of Charles Schwab’s brokerage platform, consistent core net new asset growth and double-digit profit margins, I believe SCHW is a value play and shares could easily be valued at ~15X earnings (the same level as IBKR’s shares)… which would then still be less than Charles Schwab’s 17.7X average P/E ratio in the last year. At 15X FY 2025 earnings, Charles Schwab would have a fair value of ~$68.

Risks with Charles Schwab

Interest rate-driven pressures on Charles Schwab’s deposits and net interest margin challenges have been major risks for the financial brokerage. Cash-sorting has been another challenge for Charles Schwab as well. I believe that the biggest risk for Charles Schwab relates to trading activity which can be volatile depending on the direction of the markets. Given the strength of Charles Schwab’s brokerage franchise, I believe the risks affecting the thesis are generally only of moderate character.

Final thoughts

Charles Schwab is looking at a normalization of the interest rate landscape in FY 2024 and therefore also a reversal of cash flows out of money market funds and back into its core business, which is where they could be used to achieve higher earnings. The fourth-quarter earnings report, I believe, was also much better than investors initially realized with Charles Schwab achieving solid profit margins and quite impressive core net new asset growth (in both FY 2023 and Q4’23). The ability to attract assets, in my opinion, is a key strength for Charles Schwab, especially when considering the unique market conditions of FY 2023 which caused a near-meltdown of the regional banking market. Charles Schwab remains a fortress brokerage company with considerable earnings power and strong asset gathering capabilities. These factors, together with a 14X P/E ratio, make Charles Schwab a value stock, in my opinion.