Schwab Looks to Break Through

04/28/2010 10:31 am EST

Focus: STOCKS

Elizabeth Harrow

Financial Analyst, Schaeffer's Investment Research, Inc.

Elizabeth Harrow of Schaeffer’s Research says the discount broker’s shares appear to be in limbo, and wonders whether they can move higher.

[This article in Barrons.com—"Don't Sob for Schwab," April 15th]—takes a glass-half-full look at Charles Schwab (Nasdaq: SCHW) following the brokerage firm's "disappointing first-quarter results."

Rather than selling on the news, author [Teresa Rivas] suggests that "investors might want to buy on this dip." Despite the fact that first-quarter earnings fell short of expectations, SCHW managed to increase its trading volume and add new accounts during the quarter.

As additional evidence for the bullish case, the article points to Schwab's "relatively healthy" balance sheet, as well as the equity's market-beating performance during the past five years. Plus, the brokerage should benefit from an increase in interest rates.

As a caveat to this upbeat outlook, warns the author, a lack of rate hikes from the Federal Reserve during the second half of 2010 could mean that SCHW will continue to stagnate on the charts.

If a lack of interest-rate increases is reason enough to avoid SCHW, traders may want to stay away: Key Fed members, including Chairman Ben Bernanke, have refused to commit to any kind of timetable for ratcheting rates back up towards more typical levels. With the central bank's policy changes dependent on the state of the US economy, rate hikes are hardly a foregone conclusion during the near term.

Plus, the shares are actually lingering near the high end of their trading range, which is defined by the $20 level on the upside and the $16-to-$17 neighborhood on the downside. This sideways channel has confined the equity's progress since April 2009. With SCHW currently hovering near $19, there's still room for the shares to continue their retreat during the coming weeks.

This is particularly true given the generally complacent sentiment surrounding the equity. The stock's Schaeffer's put/call open interest ratio (SOIR) of 0.87 ranks in the 43rd annual percentile, and traders bought to open nearly two times more calls than puts on the stock in the weeks leading up to its earnings report. (Brokerage Sandler O’Neill recently upgraded the shares to Buy—Editor.) A mass exodus by these bulls following SCHW's poorly received quarterly results could continue to weigh on the shares during the short term.

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