Customer Growth Prospects Put 10% of Schwab's Equity Value at Risk

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.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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