A research note by William Blair analyst Jeff Schmitt suggests that Charles Schwab’s recent struggles may soon become a thing of the past, paving the way for a significant rebound in earnings over the next two years. Schmitt asserts that the risk/reward balance is now favorable, making it an opportune time to consider investing in Schwab (ticker: SCHW).
Despite Schmitt’s positive analysis, Schwab’s shares experienced a modest decline on Tuesday, aligning with the overall market sentiment. Earlier this year, the stock suffered due to the regional bank crisis and concerns surrounding outflows from its bank. Clients had been transferring their uninvested cash from low-yielding bank accounts to higher-yielding alternatives. Consequently, this negatively impacted Schwab’s earnings since the company heavily relies on net interest revenue, with uninvested client cash being its primary funding source for interest-earning assets. As a result, the stock has plummeted by 31% so far this year.
Schmitt anticipates that Schwab’s cash sorting challenges will subside as interest rates reach their peak. This would provide considerable relief for the company. Whenever Schwab’s outflows surpass its available cash, it is forced to resort to costly funding methods like borrowing from the Federal Home Loan Bank. Schmitt believes that a decrease in interest rates and expenses will contribute to an increase in Schwab’s net interest margin.
In a research note dated September 19, Schmitt predicts that these factors will drive an average EPS growth of 30% to 35% in 2024 and 2025. Despite the positive outlook, the market has yet to fully factor in this rebound, as the stock continues to trade at levels significantly below its historical averages.
Moreover, Schmitt portrays Schwab’s valuation as highly appealing. Currently, the stock is trading at a mere 13.5 times his estimated 2024 EPS, compared to the historical average of 20 times. Schmitt argues that a multiple ranging from 18 to 19 times the projected 2024 EPS would imply a stock price of $77 to $82, representing a remarkable 35% to 40% increase from its current value.
In summary, Charles Schwab is poised for a promising resurgence in the coming years, according to William Blair’s Jeff Schmitt. With the potential for substantial growth and an attractive valuation, Schwab offers an alluring investment opportunity for those seeking long-term returns.
Schwab’s Stock Performance
Schwab’s stock has been experiencing fluctuations in recent times. Despite reaching its 52-week high of $86.63, the stock is currently trading at $57.56 as of Tuesday mid-day.
Declining Bank Deposits
The company’s second-quarter earnings report revealed a decrease in bank deposits. Compared to $326 billion in the first quarter and $442 billion during the same period last year, deposits fell to $304 billion.
Positive Outlook on Cash Flow
Schmitt, an industry expert, predicts that Schwab’s cash flow from low-interest sweep accounts will reach its lowest point in the fourth quarter before starting to recover. As this recovery takes place, Schwab plans to aggressively pay down short-term funding.
Integration with TD Ameritrade
Schwab’s acquisition of TD Ameritrade in 2020 is expected to provide long-term benefits. The company has been working on transitioning clients and advisors from TD Ameritrade to its platform, resulting in some customer attrition in July and August. However, the majority of customers and assets were successfully transferred over Labor Day weekend, which should lead to a decrease in attrition going forward.
Migration Process and Organic Growth
Schmitt states that Schwab is on track to migrate 97% of Ameritrade clients by the end of this year, with the remaining clients coming over in early 2024. As a result, organic growth may remain weak in the near term. However, it is expected to return to historical levels in 2024 and 2025 once the migration process is complete.
The company declined to comment on Schmitt’s note.