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SCHW - Charles Schwab


Spekulatius
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I searched and surprisingly didn’t see a topic in the investment section. How can there not be a topic open in an investment board for the largest asset manager? Too obvious?

 

I recently got interested in this after a few folks on twitter pointed out that SCHW is a business that shares most of its efficiency gains with their customer. Short term, this hurts the bottom line, but in the long run, it allows them to grow more than their competitors as they have the lowest cost to service apparently and keep pushing the boundaries for market share gains.

 

With interest rates heading down, their top line is going to be hurting but I am guessing that eventually, their low costs and better service  and larger scale means they have a moat which is hard to overcome and will eventually be rewarding for owners, science the current valuation isn’t exactly demanding.

 

I hope to get some discussion going here.

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I searched and surprisingly didn’t see a topic in the investment section. How can there not be a topic open in an investment board for the largest asset manager? Too obvious?

 

I recently got interested in this after a few folks on twitter pointed out that SCHW is a business that shares most of its efficiency gains with their customer. Short term, this hurts the bottom line, but in the long run, it allows them to grow more than their competitors as they have the lowest cost to service apparently and keep pushing the boundaries for market share gains.

 

With interest rates heading down, their top line is going to be hurting but I am guessing that eventually, their low costs and better service  and larger scale means they have a moat which is hard to overcome and will eventually be rewarding for owners, science the current valuation isn’t exactly demanding.

 

I hope to get some discussion going here.

 

I have to admit, this is a compelling argument around low cost provider and economy of scale.

 

I just wonder how much of a moat there is.  This has always felt like an industry where big tech could clean house.  You use a bunch of ML to choose investments, some human oversight, ML the customer service and let Alexa guide them through it. I am probably grossly underestimating the challenges but that is the risk I see.

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They make something like 60% of their net off the spread on customers' cash balances. I'm a big fan but I sold when interest rates plunged. I basically view Schwab as a bank as much as a brokerage. You have to watch NIM closely.

 

 

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They make something like 60% of their net off the spread on customers' cash balances. I'm a big fan but I sold when interest rates plunged. I basically view Schwab as a bank as much as a brokerage. You have to watch NIM closely.

 

Yes, basically my thoughts as well. It's a leveraged proxy for rising rates. If you think rates are going to rise, Schwab probably isn't a bad way to play it.

 

Otherwise, I'm not a fan of it as an investment.

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They make something like 60% of their net off the spread on customers' cash balances. I'm a big fan but I sold when interest rates plunged. I basically view Schwab as a bank as much as a brokerage. You have to watch NIM closely.

 

Yes, that’s the issue, but it is similar to the issue any bank has as well. If you invest in SCHW or any other broker or bank, you need to look past that. SCHW is valued higher on a PE basis, but it doesn’t really have the risk of crippling credit losses that banks may face. So, there are some gives and takes compared to banks.

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SCHW checks a lot of boxes.  Forward-thinking management, long-term focus on product innovation and client service, juicy margins, and the AMTD combination yields a scale monster.  They had long been preparing for the $0 trading fees hammer drop last fall - by that point, they were only ~4% of revenue.

 

Their emphasis on the independent RIA channel is an underrated advantage in my opinion.  Most of the competition treat their RIA services as a side gig and devote more resources to retail, slinging loaded funds to FAs (what year is this?), or employer sponsored plans.  RIAs are in effect a "free" salesforce for sticky assets, and continued platform innovation is low-hanging fruit for efficiency gains.  Dimensional Funds realized this decades ago and has leveraged their RIA kool-aid to great success.

 

The elephant in the room with SCHW is they are very leveraged to the x-factor of interest rates.  You could joke that the above is all just happy-talk.  I owned SCHW for a few years and my observation is that whatever credit they get for their operating progress is usually short-lived and overshadowed by rate movements/expectations (try plotting it against TLT).

 

To that end, whether SCHW is a great company at a cyclically low valuation or dead money depends largely on where you see rates moving.  Alternatively, you could use it as a non-expiring hedge should rates surprise north.

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I have owned Schw since 2012 and recently doubled my position as the stock fell under 34.  Schw and Amtd are merging...their 2019 combined net income was 5.4 billion (with net interest margin at 2.4%).  After the merger they will have 1.9 billion shares outstanding, therefore the combined entity is trading at 61 billion.  Mgmt claims they will realize 1.8 billion of cost synergies within a few years.  They also get some easy to calculate revenue synergies (they get to lower the rate on swept cash amtd paid to td bank and transfer that cash to schw bank in increments over time) but they were careful not to put any numbers on it (i believe they reluctantly said 1 billion is reasonable).  They also claimed that over time they would capture more of both numbers.  Anyway, I'm using 7-7.5 billion of earning power, or 8 times their earnings in a couple years.  However, schw consistently grows net new assets 5-8% and they have a natural revenue lift at 70% of the rise in the stock market or 3.5-4% over time (with rising margins).  As you can see their model produces high single digit revenue growth and their multiple historically reflected that and the fact that they are the low cost provider.  Interest rates are the biggest driver of earnings and their historic net interest margin of 4% doesnt look likely anytime soon.  But even with 2% NIM's with the rapidly increasing cash balances of the last few years still makes this stock very cheap. 

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I have owned Schw since 2012 and recently doubled my position as the stock fell under 34.  Schw and Amtd are merging...their 2019 combined net income was 5.4 billion (with net interest margin at 2.4%).  After the merger they will have 1.9 billion shares outstanding, therefore the combined entity is trading at 61 billion.  Mgmt claims they will realize 1.8 billion of cost synergies within a few years.  They also get some easy to calculate revenue synergies (they get to lower the rate on swept cash amtd paid to td bank and transfer that cash to schw bank in increments over time) but they were careful not to put any numbers on it (i believe they reluctantly said 1 billion is reasonable).  They also claimed that over time they would capture more of both numbers.  Anyway, I'm using 7-7.5 billion of earning power, or 8 times their earnings in a couple years.  However, schw consistently grows net new assets 5-8% and they have a natural revenue lift at 70% of the rise in the stock market or 3.5-4% over time (with rising margins).  As you can see their model produces high single digit revenue growth and their multiple historically reflected that and the fact that they are the low cost provider.  Interest rates are the biggest driver of earnings and their historic net interest margin of 4% doesnt look likely anytime soon.  But even with 2% NIM's with the rapidly increasing cash balances of the last few years still makes this stock very cheap.

 

Speaking of interest earning assets - they are exploding. 2019 YE balance was $274B; and it was growing by about 25B a year. At the end of May it's $361B!  In May alone, they added 1.25MM new brokerage accounts - that's 10X normal.

 

So business is booming. Much of that cash surge, I'm assuming, is from customers raising cash in the downturn ( March saw a $40B increase from February).

 

Looking backwards, NIM scraped along at ~1.6% from 2012-2015. That's probably where it's headed again. Of course, back then they only had $100-130B in interest-earning assets. Making 1.6% on 370B is almost $6B right there, and that doesn't count AMTD.

 

Schwab really is a beast. It's kind of mind blowing, this operation. They have 19,500 employees, custody for 7,000 RIA's

(including mine), and process a mind-boggling number of transactions. And where do they make most of their money? Scraping a couple of basis points on the cash their customers are too lazy to put in a money market. They have 14MM brokerage accounts, which by my math has an average of $26,500 cash each.

 

This thread has re-awakened my interest. Thx for the thread.

 

Edit: It's probably unwise to take that 370B as gospel. It may not last, if customers put it to work; and I'm not sure they can make margin on all of it (last Q it was noted they parked something like $58B of the cash at the Fed).

 

 

 

 

 

 

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I have owned Schw since 2012 and recently doubled my position as the stock fell under 34.  Schw and Amtd are merging...their 2019 combined net income was 5.4 billion (with net interest margin at 2.4%).  After the merger they will have 1.9 billion shares outstanding, therefore the combined entity is trading at 61 billion.  Mgmt claims they will realize 1.8 billion of cost synergies within a few years.  They also get some easy to calculate revenue synergies (they get to lower the rate on swept cash amtd paid to td bank and transfer that cash to schw bank in increments over time) but they were careful not to put any numbers on it (i believe they reluctantly said 1 billion is reasonable).  They also claimed that over time they would capture more of both numbers.  Anyway, I'm using 7-7.5 billion of earning power, or 8 times their earnings in a couple years.  However, schw consistently grows net new assets 5-8% and they have a natural revenue lift at 70% of the rise in the stock market or 3.5-4% over time (with rising margins).  As you can see their model produces high single digit revenue growth and their multiple historically reflected that and the fact that they are the low cost provider.  Interest rates are the biggest driver of earnings and their historic net interest margin of 4% doesnt look likely anytime soon.  But even with 2% NIM's with the rapidly increasing cash balances of the last few years still makes this stock very cheap.

 

Speaking of interest earning assets - they are exploding. 2019 YE balance was $274B; and it was growing by about 25B a year. At the end of May it's $361B!  In May alone, they added 1.25MM new brokerage accounts - that's 10X normal.

 

So business is booming. Much of that cash surge, I'm assuming, is from customers raising cash in the downturn ( March saw a $40B increase from February).

 

Looking backwards, NIM scraped along at ~1.6% from 2012-2015. That's probably where it's headed again. Of course, back then they only had $100-130B in interest-earning assets. Making 1.6% on 370B is almost $6B right there, and that doesn't count AMTD.

 

Schwab really is a beast. It's kind of mind blowing, this operation. They have 19,500 employees, custody for 7,000 RIA's

(including mine), and process a mind-boggling number of transactions. And where do they make most of their money? Scraping a couple of basis points on the cash their customers are too lazy to put in a money market. They have 14MM brokerage accounts, which by my math has an average of $26,500 cash each.

 

This thread has re-awakened my interest. Thx for the thread.

 

Edit: It's probably unwise to take that 370B as gospel. It may not last, if customers put it to work; and I'm not sure they can make margin on all of it (last Q it was noted they parked something like $58B of the cash at the Fed).

 

The 370B is 15% of client assets, definitely on the high side.  10-12% is the long term average and where it sits during normal times.  During the great recession it went to 23% and took a few years to normalize.  Either way, you are right assuming that the growth of the cash balance offsets much of the NIM compression.  Some sash is parked at the fed because they don't have enough capital to support it on their balance sheet.  Schw is now my second largest position behind Chtr

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They make something like 60% of their net off the spread on customers' cash balances. I'm a big fan but I sold when interest rates plunged. I basically view Schwab as a bank as much as a brokerage. You have to watch NIM closely.

 

no automatic sweeps of cash into money markets, like at Vanguard.  I once attended a dinner with a senior schwabie and pointed that out, and he changed the conversation.

 

I will say that their telephone support agents are very good

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I have owned Schw since 2012 and recently doubled my position as the stock fell under 34.  Schw and Amtd are merging...their 2019 combined net income was 5.4 billion (with net interest margin at 2.4%).  After the merger they will have 1.9 billion shares outstanding, therefore the combined entity is trading at 61 billion.  Mgmt claims they will realize 1.8 billion of cost synergies within a few years.  They also get some easy to calculate revenue synergies (they get to lower the rate on swept cash amtd paid to td bank and transfer that cash to schw bank in increments over time) but they were careful not to put any numbers on it (i believe they reluctantly said 1 billion is reasonable).  They also claimed that over time they would capture more of both numbers.  Anyway, I'm using 7-7.5 billion of earning power, or 8 times their earnings in a couple years.  However, schw consistently grows net new assets 5-8% and they have a natural revenue lift at 70% of the rise in the stock market or 3.5-4% over time (with rising margins).  As you can see their model produces high single digit revenue growth and their multiple historically reflected that and the fact that they are the low cost provider.  Interest rates are the biggest driver of earnings and their historic net interest margin of 4% doesnt look likely anytime soon.  But even with 2% NIM's with the rapidly increasing cash balances of the last few years still makes this stock very cheap.

 

Speaking of interest earning assets - they are exploding. 2019 YE balance was $274B; and it was growing by about 25B a year. At the end of May it's $361B!  In May alone, they added 1.25MM new brokerage accounts - that's 10X normal.

 

So business is booming. Much of that cash surge, I'm assuming, is from customers raising cash in the downturn ( March saw a $40B increase from February).

 

Looking backwards, NIM scraped along at ~1.6% from 2012-2015. That's probably where it's headed again. Of course, back then they only had $100-130B in interest-earning assets. Making 1.6% on 370B is almost $6B right there, and that doesn't count AMTD.

 

Schwab really is a beast. It's kind of mind blowing, this operation. They have 19,500 employees, custody for 7,000 RIA's

(including mine), and process a mind-boggling number of transactions. And where do they make most of their money? Scraping a couple of basis points on the cash their customers are too lazy to put in a money market. They have 14MM brokerage accounts, which by my math has an average of $26,500 cash each.

 

This thread has re-awakened my interest. Thx for the thread.

 

Edit: It's probably unwise to take that 370B as gospel. It may not last, if customers put it to work; and I'm not sure they can make margin on all of it (last Q it was noted they parked something like $58B of the cash at the Fed).

 

Thanks for thr number, they are helpful. The headwinds from lower NIM for the next years is something one needs to content with. SCHW is similar to banks in this respect, however compared to banks, they don’t have to content with the potential ugly loan losses. I am pretty sure that 10 years from now, they will be in as strong and perhaps stronger position relative to competition as they are today.

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Similar to banks, scale and trust would be the moat for Schwab. Its meaningful to see that TD still held onto 13% of the business once 25%+ of their business was coopted to zero fees by Schwab before purchase(this will make for a great business case). The strategic fit for TD was the deposit base and network for growth.

 

Outside bull case of a steepening yield curve, potential for revenue growth is there with increased deposit growth and new fee generating products offerings like chequing accounts/robo advisors/potentially offering loans as well. This is likely a good bet.

 

 

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Similar to banks, scale and trust would be the moat for Schwab.

 

Scale is the moat, trust/brand/stickiness all make it difficult for competitors to get to Schwab scale.  They are going to eliminate 60-65% of TD's cost base as a merged entity.  Said another way, a competitor with $1.3 trillion in assets (not small...) has to operate with $2 billion of expenses that Schwab won't have... 

 

The only real scaled competitor is Fidelity and there's no reason for them to compete aggressively to steal each others clients. JPM/BAC/MS all have ~$3T to Schwabs $5.2T (stealing 5-7% market share every year) in client assets, but with business models that are destined to lose clients to Schwab and Fidelity. 

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