Schwab's Current Troubles Mask A Bright Future

By Eugene Bukoveczky | October 21, 2009 AAA

While record low interest rates have been the appropriate prescription to revive the fortunes of the financial sector, the impact has not been universally positive. Take the example of veteran online broker Charles Schwab (NASDAQ:SCHW). With rates on money market funds now close to zero, Schwab has been forced to waive the fees it would normally charge on client's money placed in these near-cash investments. And lately, that's been costing the company dearly.
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Low Rates Hurting Fee Business
The recent quarterly numbers reveal just how much damage has been done. The company earned $200 million during its third quarter, down from $304 million a year earlier. Much of this drop is due to the $78 million in fees that has to be waived during the period. For the full year, the company expects to waive about $200 million in fees. With no signs from the Fed that U.S. rates will head higher at anytime soon, despite growing alarm about the state of the dollar, it's likely that Schwab will continue to lose fee income on its money market business for at least another year.

New Strategy
Despite the short-term pain, the company's strategy of de-emphasizing trading revenue in favor of fee-based income continues to be the right thing to do. While fast money traders continue to gravitate toward specialized technology-driven trading platforms like those operated by Interactive Brokers (NASDAQ:IBKR) and optionsXpress (NASDAQ:OXPS), and the lower trading commissions offered by rival TD Ameritrade (NASDAQ:AMTD), survey data reveals that uncertain economic times has prompted a revival in the importance of the financial advisory relationship.

And Schwab appears to be benefiting from this trend. It continues to rank highly in client satisfaction surveys, which, in turn, appears to translate into a strong new client win rate, which is up 41% year-over-year. However, at the moment, fewer dollars are going into those new accounts as many new investors remained focused on paying down debt with available cash.

Analyst Generally Neutral As Stock Treads Water
With this mixed-bag of short-term pain/long-term gain fundamentals it's a small wonder that the stock has been trapped in a sideways trading pattern since last May. The fact that most analysts covering the stock are content to sit on the fence with a "Hold" rating has no doubt added to the ongoing trading doldrums. However, one standout bullish call made by a Bank of America analyst sees the stock going to $23.50 over the next year, as a combination of top-line growth and greater cost cutting boosts profits.

The Bottom Line
After years of binge spending, tough times have forced Americans back onto a more frugal life path, which has prompted a revival in the habit of saving a proportion of one's income. If this turns out to be something more permanent than just a fear-induced hoarding move, then a leading financial services operator like Schwab stands to gain significantly. And that prospect is more than enough reason to see the stock move higher. (For related reading, check out Six Rut-Busting Business Moves For Brokers.)

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