Watch CBSN Live

​With Charles Schwab, investors can win two ways

Microsoft is buying LinkedIn in a $26.2 billion all-cash deal; Tony winner Hamilton could generate $1 billion in sales; and Apple wants a better Siri
Microsoft is buying LinkedIn in a $26.2 billi... 01:05

The stock brokerage business has always been a cutthroat, highly competitive industry that represents a big part of the good and the bad about Wall Street. But it's undeniably also a huge profit generator for the brokerage houses, especially for the mightiest in the industry, such as Goldman Sachs (GS), Bank of America Merrill Lynch (BAC) and TD Ameritrade (AMTD).

But the group's tough guy, which started out as a rebel in the brokerage business, is Charles Schwab (SCHW). It opened some 40 years ago as a discount broker and is now the leader among the big publicly traded financial services firms that focus primarily on individual investors. That group is also known as "retail investors," as opposed to the large "wholesale" institutional clients that Wall Street's much bigger investment banks and brokerage houses cater to.

But get this: Schwab counts some 9.8 million active clients, mainly individuals but also including some mutual funds and investment trusts, with total client assets amounting to about $2.5 trillion.

So it isn't surprising that Schwab's stock has been a huge winner since 2011, when it was trading at around $12 a share. Current price: $28.45, after falling to $22 a share in February when the entire market pulled back sharply. Some analysts expect Schwab's stock to continue moving higher and hit at least $39 over the next 12 months.

Part of that optimism stems from individual investors' apparently renewed interest in equities and the market. Analysts see Schwab not only as a play on the increasing market participation of individual investors but as an investment bet on rising interest rates, which many on Wall Street expect the Fed to hike again at some point, maybe soon. Schwab derives a significant portion of its revenues -- about 40 percent -- from net interest income. So a rise in short-term interest rates would significantly enhance its revenues and net interest margin.

"We see signs of the individual investor moving funds more into equities, and view this as a positive sign for Schwab's financial outlook," said Catherine Seifert, equity analyst at S&P Global Market Intelligence. Trading commissions in 2016 are likely to be up by mid-single digits as Schwab's customers move cash into equities, she added. New investor deposit accounts invariably lead to growth in asset-management fees, she pointed out.

In the first quarter of this year, those total client assets of $2.5 trillion were up 1 percent from 2015's first quarter. Not surprisingly, S&P Global Market Intelligence has a "strong buy" recommendation on Schwab. But it also elevated Schwab to "Focus Stock of the Week," which means the shares now carry S&P's highest investment recommendation. S&P has a 12-month price target of $39 a share. The price objective is based on a price-earnings (p-e) ratio of 26.5 times S&P's 2016 earnings-per-share estimate, which is still below the three-year historic average of 28.3 times, but a premium to other online brokers.

"We see steady growth in new brokerage accounts, and we see interest-earning assets growing with new account growth this year," predicts Seifert. The stock's high p-e, she noted, is supported by Schwab's strong client asset franchise and its innovation to spur future growth. Apart from the self-directed individual investors, clients looking for core guidance have access to online portfolio planning tools, professional advice from portfolio consultants who help develop investment strategy and an array of fully delegated assistance on portfolio management.

An example of innovation is Schwab's introduction of Intelligent Portfolios, the company's answer to the so-called "robo advisers," which some observers in the industry believe are the greatest threat to the traditional wealth-management industry. Many of these robo advisers use passive exchange-traded funds (ETFs) as their investment vehicle of choice, and they usually offer free advice to investors on investment plans.

Schwab's Intelligent Portfolios are automated portfolios that contain no adviser fees but provide consumers the option of interaction with a human adviser. Schwab expects it will earn enough money on the underlying ETFs and cash invested in these funds to enable it to offer the service without an advisory fee. By yearend 2015, less than a year after launching Intelligent Portfolios, their assets had grown to $5.3 billion.

With expectations of rising interest rates aided by contributions from new fee-based products and the growth of assets under management, S&P's Seifert forecasts Schwab's revenue growth at 15 percent to 17 percent in 2016, way up from last year's 5.3 percent. The analyst also expects margins based on EBIT, or earnings before interest and taxes, to widen to 40.2 percent in 2016 and 42.4 percent in 2017, up from 34.5 percent in 2015.

Seifert projects Schwab to earn $1.47 a share in 2016 and climb to $1.70 in 2017, way up from last year's $1.03 a share.

Schwab's stock hasn't been a top-drawer "buy" recommendation among most Wall Street analysts this year, but neither are any making "sell" recommendations. Credit Agricole upgraded its rating on the stock to "outperform" from "underperform" in February, and Nomura upped its recommendation to "buy" from "neutral" in January. Bank of America Merrill Lunch, however, downgraded the stock to "neutral" from "buy" in January.

Several large institutional investors hold major stakes in Schwab, led by Dodge & Cox, which owned a 7.79 percent stake as of March 31. Vanguard Group holds 5.38 percent, and Primecap Management owns 4.22 percent.

View CBS News In
CBS News App Open
Chrome Safari Continue
Be the first to know
Get browser notifications for breaking news, live events, and exclusive reporting.