Thematic evaluation
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The Charles Schwab Corp. (SCHW)

September 06, 2024

Compared to: Morgan Stanley (MS) | The Goldman Sachs Group, Inc. (GS) | Financial Select Sector SPDR Fund (XLF)

Our reasoning

Charles Schwab appears moderately undervalued based on its below-average P/E ratio, strong profitability metrics, and growth potential in managed investing solutions and improved net interest margin. While risks such as interest rate sensitivity and regulatory pressures exist, the company's strong brand, successful integration of TD Ameritrade, and focus on younger investors provide a solid foundation for future growth.

Key takeaways
  • Charles Schwab Corp. (SCHW) is a well-established financial services company with a strong brand and a diversified business model, but faces challenges in profitability and market volatility.
  • SCHW's recent integration of TD Ameritrade has expanded its client base and asset under management, but the company is still navigating integration-related costs and risks.
  • SCHW's revenue growth is expected to continue, driven by strong equity market performance and increased client engagement, particularly among younger investors.
  • SCHW's profitability is expected to improve as net interest revenue and trading revenue recover, but the company is facing pressure from higher funding costs and competition.
  • SCHW's valuation is currently below its historical averages and below its peers, suggesting that it is undervalued, but its price performance has been volatile and underperforming.
  • SCHW's future outlook is positive, with continued growth expected in the coming years, but investors should be aware of the company's exposure to economic and market risks.
  • SCHW's strong capital position and commitment to shareholder returns should provide flexibility to navigate economic and market volatility.
  • SCHW's key strengths include its strong brand, diversified business model, strong capital position, and commitment to shareholder returns.
  • SCHW's key weaknesses include its recent decline in profitability and its exposure to economic and market risks.
Undervalued
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Evaluation summary

  1. Company Overview:

    • The Charles Schwab Corp. (SCHW) is a savings and loan holding company that provides wealth management, securities brokerage, banking, asset management, custody, and financial advisory services through its subsidiaries. Its key subsidiaries include Charles Schwab & Co., Inc. (CS&Co), Charles Schwab Bank, SSB (CSB), and Charles Schwab Investment Management, Inc. (CSIM).
    • SCHW serves individual investors and institutional clients through two main segments: Investor Services and Advisor Services. Investor Services provides retail brokerage, investment advisory, and banking/trust services to individual investors, as well as retirement plan services to businesses. Advisor Services provides custodial, trading, banking/trust, and support services to independent registered investment advisors (RIAs) and retirement advisors.
    • SCHW's target market is a broad range of investors, from individual retail clients to institutional investors, with a particular focus on attracting younger investors.
    • For comparative analysis, we are using the Financial Select Sector SPDR Fund (XLF) as a benchmark and The Goldman Sachs Group, Inc. (GS) and Morgan Stanley (MS) as industry peers.

  2. Financial Performance:

    • SCHW's revenue has been growing steadily, driven by strong equity market performance and increased client engagement. However, profitability has declined in recent quarters due to lower net interest revenue and trading revenue.
    • SCHW's net profit margin and EBITDA margin have increased, indicating a growing ability to generate profit relative to its sales and before interest, taxes, depreciation, and amortization.
    • SCHW's ROA, ROE, and ROIC have been improving, indicating better asset utilization and profitability.
    • Compared to its peers, SCHW has underperformed in terms of profitability and return on equity, with lower net profit margins and ROE compared to GS and MS.

  3. Operational Efficiency:

    • SCHW has been effective in controlling operating expenses, as evidenced by the slower pace of expense growth compared to revenue growth.
    • SCHW's working capital management has been efficient, with a strong current ratio and quick ratio, indicating ample liquidity to meet short-term obligations.
    • SCHW's net operating cash flow has decreased significantly due to lower net interest revenue and trading revenue, but its free cash flow margin has been declining, indicating a potential decrease in financial flexibility.
    • SCHW's asset quality is strong, with a low level of nonperforming loans and a healthy capital structure.
    • SCHW's capital expenditure efficiency has improved, as evidenced by the decrease in total capital expenditure.
    • SCHW has a strong dividend and share repurchase history, with a consistent dividend payout and significant share buybacks.
    • Compared to its peers, SCHW has a lower debt-to-equity ratio and leverage ratio, indicating a more conservative capital structure.
    • SCHW's liquidity position has weakened, as evidenced by the decrease in cash and short-term investments and net operating cash flow.

  4. Growth Opportunities:

    • SCHW is expanding its market reach by targeting younger investors and offering a wider range of products and services, including robo-advisory and managed investing solutions.
    • SCHW has successfully completed the integration of TD Ameritrade, which has significantly expanded its client base and asset under management.
    • SCHW is exploring opportunities to utilize third-party banks to deliver extended FDIC insurance, lower capital intensity, and improve liquidity, while still meeting client banking needs.
    • SCHW is committed to offering quality lending services to clients, including residential mortgages, HELOCs, and pledged asset lines, to deepen relationships.
    • SCHW's strategic focus areas include organic growth, revenue growth, expense containment, and capital return.
    • SCHW's management has a track record of successfully executing strategic plans, as evidenced by the successful integration of TD Ameritrade and the ongoing cost reduction efforts.

  5. Risks and Threats:

    • SCHW faces risks related to economic and market conditions, including interest rate changes and equity market volatility.
    • SCHW faces operational risks related to cybersecurity, technology failures, and reliance on third-party service providers.
    • SCHW faces regulatory and compliance risks from the extensive oversight of its businesses.
    • SCHW faces integration and execution risks associated with the Ameritrade acquisition and ongoing cost reduction efforts.
    • SCHW faces competition from other financial services firms that could pressure pricing and profitability.
    • SCHW is subject to ongoing antitrust litigation related to its acquisition of TD Ameritrade.
    • SCHW faces lawsuits alleging failure to seek best execution and misrepresentations regarding order routing practices.

  6. Valuation Analysis:

    • SCHW's valuation metrics, such as P/E and EV/EBITDA, are currently below its historical averages and below its peers, suggesting that it is undervalued.
    • SCHW's valuation is expected to improve as its net interest margin recovers and its earnings growth accelerates.
    • Potential catalysts for SCHW's valuation include continued strong organic growth, improved profitability, and a more favorable interest rate environment.

  7. Price Performance:

    • SCHW's price has underperformed its benchmark, XLF, and its peers, GS and MS, over the past 60 days.
    • SCHW's price has been more volatile than its benchmark and peers, as evidenced by its higher beta.
    • SCHW's price performance is expected to improve as its earnings growth accelerates and its valuation recovers.

  8. Future Outlook:

    • SCHW's management expects revenue to be flat to up 2% in 2024, with adjusted expenses around 2% higher.
    • SCHW expects its net interest margin to reach the mid-2.20s in Q4 2024 and approach 3% by the end of 2025.
    • SCHW's earnings power is expected to build in Q4 2024, with adjusted EPS in the $0.80 to $0.90 range, and continue growing in 2025 and beyond.
    • Analyst estimates for SCHW's earnings growth are generally positive, with consensus expectations for continued growth in the coming years.

  9. Summary:

    • SCHW is a well-established financial services company with a strong brand and a diversified business model.
    • SCHW has a strong capital position and a commitment to shareholder returns, which should provide flexibility to navigate economic and market volatility.
    • SCHW's revenue growth is expected to continue, driven by strong equity market performance and increased client engagement.
    • SCHW's profitability is expected to improve as net interest revenue and trading revenue recover.
    • SCHW's earnings persistence is expected to continue to increase, indicating a growing ability to sustain profitability.
    • SCHW's cash flow is expected to continue to evolve as it completes the integration of TD Ameritrade and adjusts to the changing market environment.
    • SCHW's valuation is currently below its historical averages and below its peers, suggesting that it is undervalued.
    • SCHW's price performance is expected to improve as its earnings growth accelerates and its valuation recovers.
    • SCHW's future outlook is positive, with continued growth expected in the coming years.
    • SCHW's key strengths include its strong brand, diversified business model, strong capital position, and commitment to shareholder returns.
    • SCHW's key weaknesses include its recent decline in profitability and its exposure to economic and market risks.
    • SCHW's key opportunities include continued growth in its core businesses, expansion into new markets, and the potential for acquisitions.
    • SCHW's key threats include increased competition, regulatory changes, and economic and market volatility.
    • SCHW is a solid investment with a strong track record of growth and profitability. However, investors should be aware of the company's exposure to economic and market risks.
Peer fundamentals 
Fundamentals
Insights
  • Charles Schwab Corp. (SCHW) is a savings and loan holding company that provides wealth management, securities brokerage, banking, asset management, custody, and financial advisory services.
  • The company's revenue growth is driven by strong equity market performance and increased client engagement.
  • The company's profitability has been impacted by lower net interest revenue and trading revenue.
  • The company's liquidity position has weakened, as evidenced by the decrease in cash and short-term investments and net operating cash flow.
  • The company's long-term solvency remains strong, with a healthy capital structure and a low debt-to-equity ratio.
  • The company's earnings persistence has been increasing, indicating a growing ability to sustain profitability.
  • The company's cash flow is expected to continue to evolve as it completes the integration of TD Ameritrade and adjusts to the changing market environment.
  • The company's strong capital position and commitment to shareholder returns should provide flexibility to navigate economic and market volatility.
Analysis
  • Revenue - The company's revenue has been growing steadily, driven by strong equity market performance and increased client engagement. - The company's revenue growth is consistent with the positive investor sentiment and strong equity market performance. - The company's revenue growth is expected to continue, driven by strong equity market performance and increased client engagement.
    • Profitability
      • The company's profitability has declined, primarily due to lower net interest revenue and trading revenue.
      • The company's profitability is expected to improve as net interest revenue and trading revenue recover.
      • The company's net profit margin and EBITDA margin have increased, indicating a growing ability to generate profit relative to its sales and before interest, taxes, depreciation, and amortization.
    • Liquidity
      • The company's liquidity position has weakened, as evidenced by the decrease in cash and short-term investments and net operating cash flow.
      • The company's strong earnings and capital position provide some cushion.
      • The company's liquidity position is expected to improve as it completes the integration of TD Ameritrade and adjusts to the changing market environment.
    • Solvency
      • The company's long-term solvency remains strong, with a healthy capital structure and a low debt-to-equity ratio.
      • The company's financial leverage has decreased, as evidenced by the decrease in the total debt to total equity ratio.
      • The company's long-term solvency is expected to remain strong, with a healthy free cash flow generation and a low debt-to-equity ratio.
    • Operational Efficiency
      • The company has been effective in controlling operating expenses, as evidenced by the slower pace of expense growth compared to revenue growth.
      • The company's asset utilization efficiency has improved, as evidenced by the increase in return on average assets.
      • The company's capital expenditure efficiency has improved, as evidenced by the decrease in total capital expenditure.
    • Cash Flow Analysis
      • The company's net operating cash flow has decreased significantly due to lower net interest revenue and trading revenue.
      • The company's free cash flow margin has been declining, indicating a potential decrease in financial flexibility.
      • The company's cash flow is expected to continue to evolve as it completes the integration of TD Ameritrade and adjusts to the changing market environment.
    • Risk Factors
      • The company faces risks related to economic and market conditions, including interest rate changes and equity market volatility.
      • The company faces operational risks related to cybersecurity, technology failures, and reliance on third-party service providers.
      • The company faces regulatory and compliance risks from the extensive oversight of its businesses.
      • The company faces integration and execution risks associated with the Ameritrade acquisition and ongoing cost reduction efforts.
      • The company faces competition from other financial services firms that could pressure pricing and profitability.
    • Future Outlook
      • The company's revenue growth is expected to continue, driven by strong equity market performance and increased client engagement.
      • The company's profitability is expected to improve as net interest revenue and trading revenue recover.
      • The company's earnings persistence is expected to continue to increase, indicating a growing ability to sustain profitability.
      • The company's cash flow is expected to continue to evolve as it completes the integration of TD Ameritrade and adjusts to the changing market environment.
      • The company's strong capital position and commitment to shareholder returns should provide flexibility to navigate economic and market volatility.
Most recent earnings report
Financial statements 
All public filings
Comparative Analysis
Benchmarks (as of 2024-09-04)
Financial Select Sector SPDR Fund (XLF)
  • Performance Comparison:
    • SCHW has consistently underperformed XLF over all the periods analyzed, with a significant underperformance in the 2-year and 3-year periods. This suggests that SCHW has struggled to keep pace with the broader financial sector.
  • Risk and Return Analysis:
    • SCHW has provided lower annualized returns than XLF over all the periods analyzed. This suggests that SCHW has not been as profitable as the benchmark.
    • SCHW has been more volatile than XLF, as evidenced by its higher annualized volatility. This indicates that SCHW is a riskier investment than XLF.
    • SCHW has experienced a significantly larger maximum drawdown than XLF, indicating that it is more susceptible to significant price drops. This further reinforces its riskier profile.
  • Risk-Adjusted Performance:
    • XLF has consistently offered a better risk-adjusted return than SCHW, as indicated by its higher Sharpe ratio. This suggests that XLF has been more efficient in generating returns relative to its risk.
    • SCHW's higher beta suggests that it is more sensitive to market movements than XLF. This means that SCHW's price is likely to fluctuate more in response to changes in the overall market.
  • Overall Assessment:
    • SCHW has underperformed XLF in terms of both absolute and risk-adjusted returns. Its higher volatility and larger drawdowns indicate a riskier profile. While its recent trends suggest some improvement in its risk profile, it remains a more volatile investment than XLF. Investors seeking a more stable and potentially higher-returning investment within the financial sector may prefer XLF.
Peers Price History(as of 2024-09-04)
Morgan Stanley (MS)The Goldman Sachs Group, Inc. (GS)
  • Performance Comparison:
    • SCHW has consistently underperformed its peers, GS and MS, across all historical periods. This underperformance is particularly pronounced in the longer-term periods, such as the 3-year and 2-year annualized returns.
    • SCHW's performance has been less consistent than its peers, with periods of both outperformance and underperformance. GS and MS have shown more consistent outperformance.
  • Risk and Return Analysis:
    • SCHW has provided lower annualized returns than its peers, GS and MS, across all historical periods. This suggests that SCHW has not been as successful in generating returns for investors.
    • SCHW has exhibited higher annualized volatility than its peers, GS and MS, indicating that its price movements are more erratic and unpredictable. This higher volatility suggests a higher risk profile for SCHW.
    • SCHW has experienced a significantly larger maximum drawdown than its peers, GS and MS. This indicates that SCHW is more susceptible to significant price declines, further highlighting its higher risk profile.
  • Risk-Adjusted Performance:
    • SCHW's Sharpe ratio has been consistently lower than its peers, GS and MS, indicating that it has not offered a better risk-adjusted return. This suggests that investors have not been adequately compensated for the higher risk associated with SCHW.
    • SCHW's beta value is consistently above 1, indicating that it is more sensitive to market movements than GS, which is more closely aligned with the market. This suggests that SCHW's price will fluctuate more significantly than the overall market, further highlighting its higher risk profile.
  • Overall Assessment:
    • SCHW has consistently underperformed its peers, GS and MS, across all historical periods, with lower returns and higher volatility. This suggests that SCHW is a higher-risk investment that has not been as successful in generating returns for investors.
    • SCHW's higher volatility and larger maximum drawdown further highlight its risk profile. Investors seeking a more stable and less risky investment may consider GS or MS.
    • While SCHW's recent trends suggest a potential stabilization in its volatility and drawdowns, it remains a higher-risk investment with lower returns compared to its peers.
Peers Fundamentals(as of 2024-06-30)
Morgan Stanley (MS)The Goldman Sachs Group, Inc. (GS)
  1. Market Position and Size:
    • The Charles Schwab Corp. (SCHW) is significantly smaller than its peers, The Goldman Sachs Group, Inc. (GS) and Morgan Stanley (MS), based on market capitalization. SCHW's market cap of 113642.0 is 41302.0 less than GS's market cap of 154944.0 and 48387.0 less than MS's market cap of 162029.0. This size difference is reflected in SCHW's revenue, EBITDA, and net income, which are all significantly lower than its peers.
  2. Profitability and Efficiency:
    • SCHW exhibits significantly higher profitability metrics compared to its peers and industry averages. Its Gross Profit Margin of 74.88% is 1.4% greater than the industry average of 73.48%. SCHW's EBITDA Margin of 44.01% is 20.72% greater than the industry average of 23.29%, and its EBIT Margin of 38.31% is 17.53% greater than the industry average of 20.78%. SCHW's Net Profit Margin of 20.98% is 9.81% greater than the industry average of 11.17% and significantly higher than GS's 9.73% and MS's 11.63%. This strong profitability is notable considering SCHW's smaller size and lower revenue compared to its peers.
    • SCHW demonstrates superior efficiency in generating returns compared to its peers and industry averages. Its Return on Average Assets of 1.01% is 0.31% greater than GS's 0.7% and 0.13% greater than MS's 0.88%, but significantly lower than the industry average of 3.52%. SCHW's Return on Average Total Equity of 12.0% is 2.47% greater than GS's 9.53% and 1.64% greater than MS's 10.36%, but 1.85% lower than the industry average of 13.85%. SCHW's Return on Average Total Capital of 8.58% is 6.62% greater than GS's 1.96% and 5.57% greater than MS's 3.01%, but 2.29% lower than the industry average of 10.87%. SCHW's Return On Average Invested Capital of 5.08% is 1.82% greater than GS's 3.26% and 2.22% greater than MS's 2.86%, but 4.58% lower than the industry average of 9.66%. These strong returns on capital suggest that SCHW is effectively utilizing its assets and generating profits efficiently, despite its smaller size.
  3. Financial Health and Stability:
    • SCHW's liquidity and solvency metrics are generally favorable compared to its peers and industry averages. Its Total Debt to Total Equity Ratio of 129.33% is significantly lower than GS's 534.66% and MS's 372.43%, and also lower than the industry average of 188.45%. This indicates that SCHW has a more conservative debt structure compared to its peers. However, SCHW's Debt / EBITDA ratio of 5.47% is slightly lower than the industry average of 6.46%, suggesting a slightly higher leverage level. SCHW's Cash Flow / Total Debt ratio of 13.26% is significantly higher than GS's 2.65% and MS's 4.48%, and also much higher than the industry average of 142.03%. This indicates that SCHW has a strong ability to cover its debt obligations with its cash flow.
  4. Valuation and Market Perception:
    • SCHW's valuation metrics are generally higher than its peers and industry averages. Its Enterprise Value To Sales ratio of 6.34 is 2.75% greater than the industry average of 3.59%, and significantly higher than GS's 6.56 and MS's 5.2. SCHW's Enterprise Value To EBITDA ratio of 15.53 is 4.0% lower than the industry average of 19.53%. SCHW's Price To Earnings ratio of 26.55 is 10.8% greater than GS's 15.75 and 10.06% greater than MS's 16.49, but significantly lower than the industry average of 89.69%. SCHW's Price to Book Ratio of 3.27 is 1.82% greater than GS's 1.45 and 1.51% greater than MS's 1.76, but 0.4% lower than the industry average of 3.67%. SCHW's Price To Sales Ratio of 4.6 is 0.96% greater than the industry average of 3.64%, and significantly higher than GS's 1.36 and MS's 1.57. These higher valuation metrics suggest that the market is placing a premium on SCHW's profitability, growth prospects, and financial stability.
  5. Cash Flow and Capital Management:
    • SCHW's cash flow generation is significantly lower than its peers, considering their market caps. Its Net Operating Cash Flow of -4264.0 is 23567.0 less than GS's 19303.0 and 3353.0 greater than MS's -7617.0. SCHW's Total Capital Expenditure of 89.0 is 453.0 less than GS's 542.0 and 762.0 less than MS's 851.0. SCHW's Free Cash Flow of -4353.0 is 23114.0 less than GS's 18761.0 and 4115.0 greater than MS's -8468.0. This suggests that SCHW may be investing more heavily in its business or experiencing challenges in generating cash flow from operations.
  6. Growth and Future Prospects:
    • SCHW's growth trends show a mixed picture compared to its peers. SCHW's 3-year CAGR for Sales/Revenue, in millions is 16.12%, which is lower than GS's 23.83% and MS's 21.29%, but slightly higher than the peer average of 20.41%. SCHW's 5-year CAGR for Sales/Revenue, in millions is 16.64%, which is lower than GS's 18.22% but higher than MS's 14.76% and the peer average of 16.54%. SCHW's 3-year CAGR for EBITDA is 12.24%, which is equal to the peer average of 12.24%. SCHW's 5-year CAGR for EBITDA is 13.63%, which is also equal to the peer average of 13.63%. SCHW's 3-year CAGR for Net Income is 2.01%, which is significantly higher than GS's -17.74% and MS's -8.81%, and also higher than the peer average of -8.18%. SCHW's 5-year CAGR for Net Income is 5.29%, which is higher than GS's 2.92% and MS's 4.71%, and also higher than the peer average of 4.31%. SCHW's 3-year CAGR for Basic Earnings per Share is 0.55%, which is significantly higher than GS's -17.07% and MS's -6.96%, and also higher than the peer average of -7.82%. SCHW's 5-year CAGR for Basic Earnings per Share is -2.03%, which is lower than GS's 5.57% and MS's 5.69%, and also lower than the peer average of 3.08%. SCHW's 3-year CAGR for Total Assets is -3.56%, which is lower than GS's 9.65% and MS's 3.03%, and also lower than the peer average of 3.04%. SCHW's 5-year CAGR for Total Assets is 10.87%, which is lower than GS's 11.81% but higher than MS's 6.62% and the peer average of 9.77%. SCHW's 3-year CAGR for Book Value Per Share is -9.71%, which is lower than GS's 9.06% and MS's 2.26%, and also lower than the peer average of 0.54%. SCHW's 5-year CAGR for Book Value Per Share is 5.62%, which is lower than GS's 9.1% but higher than MS's 5.6% and the peer average of 6.77%. SCHW's 3-year CAGR for EBIT Margin is -3.33%, which is equal to the peer average of -3.33%. SCHW's 5-year CAGR for EBIT Margin is -4.27%, which is also equal to the peer average of -4.27%. SCHW's 3-year CAGR for Return on Average Total Equity is 10.01%, which is significantly higher than GS's -16.8% and MS's -9.13%, and also higher than the peer average of -5.3%. SCHW's 5-year CAGR for Return on Average Total Equity is -5.39%, which is lower than GS's -5.37% and MS's -1.45%, and also lower than the peer average of -4.07%.
    • SCHW's growth rates have been consistently decreasing over the 5-year period for Basic Earnings per Share, Free Cash Flow, Free Cash Flow Margin, Total Assets, Book Value Per Share, and Return on Average Total Equity. SCHW's most recent year-over-year growth rates are lower than its 5-year CAGRs for Sales/Revenue, in millions, EBITDA, Net Income, Basic Earnings per Share, Free Cash Flow, Free Cash Flow Margin, Total Assets, Book Value Per Share, EBIT Margin, and Return on Average Total Equity, indicating a deceleration trend.
    • SCHW's growth is concentrated in specific areas, particularly in Net Income, Basic Earnings per Share, and Return on Average Total Equity. However, there are concerns about the sustainability of these growth rates, as they have been declining over the past 5 years.
  7. Potential for Investment:
    • SCHW presents an interesting investment proposition with both potential advantages and disadvantages. Its strong profitability, efficient returns on capital, and conservative debt structure make it a financially sound company with a lower risk profile. Its focus on retail brokerage and wealth management services has allowed it to achieve strong profitability and carve out a niche market. However, SCHW's lower growth rates and cash flow generation compared to its peers raise concerns about its ability to sustain its current performance and compete effectively in the long term. Investors should carefully consider SCHW's growth trajectory and cash flow generation capabilities before making an investment decision.
  8. Key Risks and Considerations:
    • SCHW's lower growth rates and cash flow generation compared to its peers are significant risks for investors. If SCHW is unable to accelerate its growth and improve its cash flow generation, it may struggle to maintain its competitive position and profitability in the long term.
    • The increasing competition in the financial services industry, particularly in the retail brokerage and wealth management sectors, could also pose a challenge for SCHW.
    • SCHW's reliance on technology and innovation to maintain its competitive edge could also be a risk factor. If SCHW is unable to keep up with technological advancements, it could lose market share to more innovative competitors.
  9. Overall Assessment:
    • The Charles Schwab Corp. (SCHW) is a financially sound company with strong profitability and efficiency metrics. However, its lower growth rates and cash flow generation compared to its peers raise concerns about its ability to sustain its current performance and compete effectively in the long term. Investors should carefully consider these risks and SCHW's growth trajectory before making an investment decision.