Charles Schwab Will Win on Tax Reform Despite Short-Term Hit

January 2, 2018 — 2:20 PM EST

Charles Schwab warned that the tax reform bill, which was signed into law by President Donald Trump ahead of Christmas, will result in a near-term hit, but over the longer term, the discount brokerage is expected to benefit.

The Charles Schwab Corporation (SCHW) was among the first to provide commentary on what tax reform means to its business. In a blog post, Chief Financial Officer Peter Crawford warned that the firm could see an increase in its tax expenses in the fourth quarter and that about $50 billion in assets that can no longer be deducted will "slightly" offset the reduction in its new tax rate. Still, he sounded an optimistic tone, saying that, "for 2018 and beyond, we estimate a net reduction in our tax rate of 11.5% to 12.0% from this law."

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With the San-Francisco-based discount brokerage's corporate tax rate dropping to 21% from 35% this year, SunTrust analyst Robinson Humphrey is upbeat about how the new tax bill will affect Schwab, even if there is a near-term hit. "A steep cut to the corporate tax rate creates a windfall for Schwab and the other brokers, on top of any earnings increase from rising rates on the middle to back end of the yield curve," wrote Humphrey along with fellow SunTrust analysts Douglas Mewhirter and Michael Ramirez in a recent research note that was covered by Barron's. "It remains to be seen how much of this windfall (if any) will be spent in the form of higher salaries, increased marketing, or lower prices."

The SunTrust analysts raised their Schwab EPS estimate for 2018 to $2.35 per share from $1.99 as a result of the changes to the tax code. The analyst consensus for Charles Schwab's full-year earnings per share in 2018 stands at $2.01. In addition to upping their estimate, the analysts increased their price target to $63 from $56 per share and reiterated their buy rating on the stock. Shares of Charles Schwab were recently trading down $0.03, or 0.07%, to $51.33. SunTrust's price target of $63 per share implies that Schwab stock can gain more than 23% this year.

Heading into the signing of the tax reform bill, expectations were high that Schwab would benefit if the bill received approval. Trefis.com, a platform created by a team of MIT engineers and Wall Street analysts that helps investors understand how companies' products affect share prices, recently said that Schwab's valuation could see a 20% increase from a reduction in the corporate tax rate. "The effective tax rate paid by Charles Schwab, around 37% in the past five years, is in fact much higher than that paid on average by other companies in the U.S.," Trefis wrote in a recent blog post for Forbes. The investment researchers estimate that the brokerage's effective tax rate last year was 36.9%, with the firm paying taxes of $1.1 billion. If that rate were lowered to 22%, the tax liability would have declined to $660 million and increased the company's net income by close to 25%.