Has Schwab Become the Perfect Stock?

Every investor would love to stumble upon the perfect stock. But will you ever really find a stock that provides everything you could possibly want?

One thing's for sure: You'll never discover truly great investments unless you actively look for them. Let's discuss the ideal qualities of a perfect stock, then decide if Charles Schwab (NYSE: SCHW  ) fits the bill.

The quest for perfection
Stocks that look great based on one factor may prove horrible elsewhere, making due diligence a crucial part of your investing research. The best stocks excel in many different areas, including these important factors:

  • Growth. Expanding businesses show healthy revenue growth. While past growth is no guarantee that revenue will keep rising, it's certainly a better sign than a stagnant top line.
  • Margins. Higher sales mean nothing if a company can't produce profits from them. Strong margins ensure that company can turn revenue into profit.
  • Balance sheet. At debt-laden companies, banks and bondholders compete with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.
  • Money-making opportunities. Return on equity helps measure how well a company is finding opportunities to turn its resources into profitable business endeavors.
  • Valuation. You can't afford to pay too much for even the best companies. By using normalized figures, you can see how a stock's simple earnings multiple fits into a longer-term context.
  • Dividends. For tangible proof of profits, a check to shareholders every three months can't be beat. Companies with solid dividends and strong commitments to increasing payouts treat shareholders well.

With those factors in mind, let's take a closer look at Schwab.

Factor

What We Want to See

Actual

Pass or Fail?

Growth

5-year annual revenue growth > 15%

(0.7%)

Fail

 

1-year revenue growth > 12%

2.6%

Fail

Margins

Gross margin > 35%

93.5%

Pass

 

Net margin > 15%

19.3%

Pass

Balance sheet

Debt to equity < 50%

18.8%

Pass

 

Current ratio > 1.3

0.58

Fail

Opportunities

Return on equity > 15%

10.8%

Fail

Valuation

Normalized P/E < 20

25.37

Fail

Dividends

Current yield > 2%

1.4%

Fail

 

5-year dividend growth > 10%

3.7%

Fail

       
 

Total score

 

3 out of 10

Source: S&P Capital IQ. Total score = number of passes.

Since we looked at Schwab last year, the company has given back both points it gained from 2011 to 2012. Valuations rose and dividend growth fell, but investors have been quite happy with the stock, as it has risen by about 30% over the past year.

As a discount broker, Schwab makes money when its customers are excited about investing. Although the company has done a good job of bringing in new accounts and assets, daily average trading volume was relatively weak throughout much of 2012, as low trading volumes on major U.S. stock exchanges hurt activity levels overall. More recently, though, activity has started to pick up, with Schwab reporting gains of nearly 17% in average trading volume from November to January. Moreover, massive outflows from mutual funds throughout 2012 reversed themselves last month as investors reacted to big gains in the stock market.

But the big news for Schwab lately has been its major push into the exchange-traded fund market. After having been the first to offer commission-free ETFs in 2009, Schwab recently expanded its offerings with its ETF OneSource marketplace, with more than 100 different ETFs from multiple ETF providers, including No. 2 industry player State Street (NYSE: STT  ) . The move not only gives State Street's SPDR line of ETFs a dedicated distribution channel but also helps Schwab go up against rival broker TD Ameritrade (NYSE: AMTD  ) , which was the first to offer a 100+ fund menu of commission-free ETFs on its platform.

Schwab has also sought to expand its financial product offerings, most recently by offering a variable annuity geared at generating retirement income. Rival financial companies Hartford Financial (NYSE: HIG  ) and Genworth Financial (NYSE: GNW  ) have reined in their annuity offerings, with Hartford suspending all new sales and seeking to buy out some of its variable annuity holders, and Genworth having stopped selling retail and group variable annuities a couple of years ago. Both companies suffered from adverse conditions in the annuity market during the financial crisis, but Schwab sees promise in the products, which will be backed by insurer Pacific Life.

For Schwab to improve, it needs to see further gains in customer activity and do a better job of converting that activity to revenue and income. With a favorable stock market, Schwab needs to take advantage before a market reversal sours investors once again.

Keep searching
No stock is a sure thing, but some stocks are a lot closer to perfect than others. By looking for the perfect stock, you'll go a long way toward improving your investing prowess and learning how to separate out the best investments from the rest. 

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Click here to add Schwab to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.


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