NIMSCHW
Charles Schwab SCHW, one of the leading brokerage firms in the United States, has seen its stock plunge more than 14% in a month. This fall is steeper than the 7.5% and 6.4% declines of the industry it belongs to and the S&P 500, respectively. One-Month Price Performance What Triggered the Sell-off in the SCHW Stock? If you see the above chart, Schwab shares started falling after the second-quarter 2024 results were announced on Jul 16 and are yet to recover.
Though SCHW’s earnings and revenues met the respective Zacks Consensus Estimate, overall performance was weak. On a sequential basis, net revenues of $4.69 billion dipped 1%. Lower bank deposit account fees (down 16%), net interest income (3%) and trading revenues (5%) were the primary reasons behind subdued top-line performance.
Further, clients' Daily Average Trades (DATs) fell 8% from the first-quarter level to 5.49 million. The company doesn’t expect any improvement in DAT volume for the remaining two quarters of 2024.
Management noted that higher funding costs are weighing on its performance. Hence, as it deals with the low-yielding assets bought during the pandemic, the company plans to shrink itself to sustain profits and rely more on off-balance sheet arrangements to house deposits.
This plan to shift toward the capital-light business model is expected to provide flexibility with its funding, though it will likely result in significant earnings volatility during future rate cycles.
Also, the company’s net interest margin NIM did not record growth in the first half of 2024, given the increased funding costs and the presence of low-yielding assets on its balance sheet. SCHW projects NIM to reach around 2.2% by the fourth quarter of 2024, with average interest-earning assets contracting 5-10% from the prior-year quarter. Also, interest rate cuts by the Federal Reserve will put pressure on NIM growth in the near term. Earlier, the company had guided NIM to be in the 2.25-2.65% range.
The company intends to pay off these low-yielding assets from the additional liquidity made available by suspending share repurchases.
All these factors triggered the sell-off in Schwab shares. This was further compounded by a broader market plunge because of overblown recession fears as the unemployment rate rose to a 3-year high of 4.3% in July.
Earnings Estimate Trajectory
Analysts seem to be bearish about Schwab’s prospects. Over the past seven days, the Zacks Consensus Estimate for 2024 and 2025 earnings has moved lower.
Estimate Revision Trend
Trading Below Key Moving Average
Adding to investors’ concerns, since Jul 16, Schwab shares are trading below their 50-day moving average, a technical indicator often seen as a bearish signal. This movement suggests a potential continuation of the downward trend, at least in the short term.
50-Day Moving Average
Lofty Valuation
Further, Schwab’s valuation remains a point of contention. The stock's forward 12-month price-to-earnings (P/E) ratio is significantly higher than the industry average, indicating that much of its expected growth is already factored into the stock price. This leaves little room for error and makes the stock vulnerable to any unfavorable developments or earnings misses.
Price-to-Earnings (Forward 12 Months)
Also, the SCHW stock is trading above its peers like Interactive Brokers IBKR and LPL Financial LPLA. At present, IBKR is trading at 16.05X forward 12-month P/E and LPLA at 10.69X.
What Supports Schwab
Despite the near-term headwinds plaguing the stock, Schwab remains fundamentally solid. The company became a brokerage behemoth following the acquisition of TD Ameritrade (“TDA”) in 2020.
On May 13, SCHW completed its fifth and final round of client account transitions associated with the TDA deal, marking the closure of “a historic integration.” The company remains on track to complete the remaining integration-related work by this year's end. These include decommissioning remaining systems and data centers, removing duplicative platforms as well as realizing the remaining almost 20% of the $1.8-$2 billion run-rate expense synergy target. The company expects TDA client attrition to finish favorably at its initial expectation of 5-6%.
Schwab anticipates its long-term 5-7% annual growth trajectory in net new assets (NNA), with 3-5% NNA growth expected from existing clients and 2-3% improvement in NNA by attracting new clients.
Further, the demand for Schwab’s managed investing solutions, in which it has massively invested over the last few years, continues to increase. In the first half of 2024, managed assets touched $636 billion, and net flows were $25 billion, surging 56% from the first half of 2023.
All these are expected to support Schwab’s organic growth over time. Also, its plan to shift from a traditional balance sheet-driven business model over the next several years will help lower capital needs and improve the liquidity profile.
End Note
Schwab’s long-term story remains intact.
However, the near-term challenges are likely to weigh on its top-line growth. With declining earnings estimates and abysmal valuation compared with its peers, the stock is witnessing negative investor sentiments. Also, it needs to be seen how Schwab’s plan to become a capital-light business turns out to be over time.
So, it might not be a wise investment decision to bet on the stock at the moment. SCHW carries a Zacks Rank #5 (Strong Sell), at present.
You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
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