Charles Schwab Corporation
(
SCHW
) is an online brokerage, banking and financial services firm. It
competes with firms like E-Trade (
ETFC
), Ameritrade (
AMTD
),
Wells Fargo
(
WFC
) and Bank of America (
BAC
).
Our $19.89 price estimate for Charles Schwab
stands roughly 7% ahead of market value. But is this premium at
risk due to a potential drop off of customer growth? Here we
highlight a scenario that suggests we might be giving the company's
growth prospects a bit too much credit. If this is indeed the case,
our base price estimate might be overvaluing the company by a full
10%.
Contrary to traditional belief, trading commissions are not the
biggest source of revenues for brokerage firms. These firms earn
most of their income by investing customer assets that are held as
deposits, loans and other securities. With online brokerage firms
able to generate interest yields of up to 5% on these assets, the
interest income is the biggest contributor to the firm's
value. According to our analysis, interest on these assets
represents almost 50% of Charles Schwab's total equity value.
Online Brokerage Firms are Riding High on Investor
Sentiments
Investors have shown ample enthusiasm for shares of companies in
the online brokerage industry. One key reason bolstering
shares of online brokerage companies is their increasing adoption
among first-time investors. With the financial markets showing
gradual improvement after the global economic recession of 2008,
first-timers looking for their share of the financial growth pie
are turning towards online brokerage firms like Charles Schwab and
its competitors because of their convenience and ease of use.
Moreover, online brokerages have been successful in attracting
customers from traditional brokerage firms. The likely culprits
here are the fees and commissions charged, as online brokerages
provide services similar to traditional brokerages at considerably
lower costs to the end customer.
But What if the Rate of Customer Adoption Slows?
We forecast that the number of active trading accounts with
Charles Schwab will climb steadily from roughly 8 million today to
nearly 11 million by the end of our forecast period.
But if the rate of customer adoption slows, there will likely be
two simultaneous effects. Consider the scenario that the number of
accounts reaches only 10 million by the end of our forecast period,
almost 10% below our base estimate of 11 million. This would
decrease our estimate for Charles Schwab's value by less than 2%,
not a sufficient reason to be ringing the alarm.
The Real Concern - A 10% Decline in Equity Value
The real concern is that this would directly affect the assets
available to Charles Schwab for investment. This, in turn, would
reduce its interest income, the single largest source of revenue
for the company.
The 10% reduction in the number of customers added could spur a
drop in asset value from our current end-of-forecast-period
estimate of $118 billion to below $100 billion. This change can
shave a notable 8% off of
our $19.89 price estimate for Charles Schwab
, dropping our number to $18.30. As our price estimate currently
stands about 7% ahead of market price, this scenario would bring
our estimated stock value in line with market price.
Combined, these scenarios suggest that a 10% decline in Charles
Schwab's customer totals could spark a 10% decline in the company's
equity value.