Last week, I introduced you to the king of online brokers and FOOL 50 company, Charles Schwab (NYSE: SCH). After addressing its financials last week, I promised to address its qualitative characteristics this week. Um, I lied. Before we get to the qualitative measures, we need to finish last week's financial analysis. I'll get to the subjective stuff next week -- I promise. Since my last column, Schwab reported earnings for calendar year 2000, so we can update our Finance King ratios.
Revenue growth came in at a whopping 47% for the year, even though fourth-quarter revenue was up only 5% sequentially. Commission revenue represented only 40% of revenues (down from 76% in 1992), while asset management and administration fees jumped from 19% to 27% of total revenue. The 10-year revenue compound annual growth rate now stands at 31%. Incredible.
The efficiency margin (1 minus the efficiency ratio) skirted the 20% requirement with a 21% showing, down from 25% in 1999. Net margins also slid from 14.9% in 1999 to 12.4%, but still bested our 10% goal. As you recall, asset turnover was borderline over the last 10 years, but Schwab continued its improvement trend and turned in a 0.17, beating our 0.16 target and was up from 0.15 last year. The leverage factor also improved to 9.9, easily qualifying under our 15.0 ceiling.
Now, for the fun stuff! As I mentioned last week, the product of the net margin, asset turnover ratio, and leverage factor is return on equity (ROE). This trifecta is called the DuPont Analysis and is calculated as follows:
ROE = Net Margin x Asset Turnover x Leverage Factor ROE = Net Income x Revenues x Total Assets Revenues Total Assets S/H Equity
Using a little high school algebra, we see that revenues and total assets can be cancelled out and we are left with ROE = Net Income / Shareholder Equity. This shorter equation simplifies the calculation, but does not provide investors with as much insight into the components of ROE. The DuPont Analysis provides a compartmentalized look into ROE and allows us to calculate a minimum ROE based on our stated targets. (Remember: net margin > 10%, asset turnover > 0.16, and leverage factor < 15.)
Multiplying our net margin target of 0.10 by asset turnover of 0.16 and by a leverage factor of 15 yields a minimum ROE of 24% for Finance Kings. For calendar year 2000, Schwab falls short of this goal with a 21.1% ROE. This marks Schwab's lowest ROE in the last 10 years.
How is it possible that Schwab can meet all our criteria and fall short of our ROE goal? The answer can be found in the leverage factor. (Recall that leverage, in the financial sense, is synonymous with debt.) The historical trend of our three ROE components tells the story:
Net Margin 1995 1996 1997 1998 1999 2000 12.2% 12.6% 11.7% 12.7% 14.9% 12.4% Asset Turnover 1995 1996 1997 1998 1999 2000 0.15 0.15 0.15 0.14 0.15 0.17 Leverage Factor 1995 1996 1997 1998 1999 2000 16.8 16.4 15.1 15.1 12.9 9.9Note, the first two components (net margin and asset turnover), when multiplied, give us return on assets (ROA).