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Top Picks 2018: Charles Schwab Corporation (SCHW)

01/15/2018 5:00 am EST

Focus: FINANCIALS

Joe Laszewski, CFA,CPA

Senior Portfolio Manager, Stack Financial Management

Charles Schwab Corporation (SCHW) and its subsidiaries serve both individual and institutional U.S. investors through a broad array of financial services including wealth management, securities brokerage, banking, asset management, custody, and financial advisory services, notes Joe Laszewski, senior portfolio manager for Stack Financial Management and contributing editor to InvesTech Research.

Schwab boasts a premium brand, strong balance sheet, and impressive growth prospects along with being positively linked to rising short-term interest rates. 

The company stands to benefit from today’s monetary environment. As short-term interest rates continue to rise, SCHW will earn an incrementally greater net interest margin on its growing pool of interest-earning assets.

With three ¼ ppt interest rate-hikes from the Federal Reserve in 2017, Schwab grew net interest income by nearly +30% to its highest level since 2010. While this pace of growth may be difficult to maintain, the firm is positioned to be a primary benefactor should the Federal Reserve continue normalizing interest rates in 2018. 

Independent of the path of interest rates, however, the company offers organic growth prospects that are unparalleled by its peers. The company’s long-term operating initiatives to reduce trading costs, bolster technology investment, lower ETF expenses, and offer more advisory platform services continue to drive asset growth.

As a result, Schwab has seen high double-digit annual growth in assets across virtually all business lines, and recently reported their ninth straight quarter of record net revenues.

Schwab’s scale and efficiency are competitive advantages that allow the company to grow revenues by taking market share away from smaller competitors. Schwab is positioned as a low-cost leader, sporting an expense to average client assets of 17 basis points (bps), with the next closest competitor at 28bps and the rest of the group considerably higher.

The company’s scale is also translating to the bottom-line, as Schwab has done a good job controlling expenses despite strong growth. This is evidenced by 2017 year-to-date net revenue and earnings growth of +16% and +27%, respectively, while expenses have only grown by 10%. 

Schwab has delivered strong and consistent growth, especially for a financial firm. As such, it trades at a premium P/E ratio of about 26 based on fiscal 2018 earnings per share of $1.98. Yet, this higher valuation is justified by the company’s sterling balance sheet and impressive growth prospects.

Additionally, the company is likely to benefit from recently enacted corporate tax reform. Continued flattening of the yield curve would be a risk to the investment thesis, although less so than for traditional banking institutions.

In a sector dominated by value-oriented investment opportunities, Schwab is a true growth story. The company is a well-managed disruptor in its industry that trades at a premium to peers. However, future growth within the industry is likely to be driven by market share gains and Schwab’s business model has the company well positioned to continue taking share. 

The company also has strong growth potential as short-term interest rates continue to rise, making it a timely portfolio idea for 2018. Note: Clients and individuals associated with Stack Financial Management hold positions in, and may from time to time make purchases or sales of, this security. 

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