In October, Charles Schwab (SCHW 1.28%) closed on one of the biggest deals in the financial sector this year when it acquired rival brokerage firm TD Ameritrade. The combined entity becomes the largest brokerage firm in the country with about $6 trillion in assets under management, 8 million brokerage accounts, and more than 5 million daily average trades.
Since the deal closed on Oct. 6, Schwab's stock price has jumped about 38% to its current price of around $50 per share. It is up about 6% year to date after being down double-digit percentages for most of the year. The market has obviously reacted favorably to the move, but is it a short-term spike or a long-term trend? Let's look a little deeper to see if Schwab is a buy.
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Schwab scores a TD in 2020
Operations will take about 18 to 36 months to integrate, so for now, the two brokerage houses will operate separately, servicing their own clients as they have in the past. But long-term, the deal has two major benefits for Schwab. The company expects the added scale will lower operating expenses as a percentage of client assets. In turn, that will enable the company to invest in technology and initiates to improve the client experience.
Also, the combined entity will be able to offer a broader range of services for both investors and its clients who are registered investment advisors (RIAs). It has already begun to do that by integrating TD Ameritrade's thinkorswim and thinkpipes trading platforms for individual and institutional clients into its offerings. It is also incorporating TD Ameritrade iRebal rebalancing solution for its advisor clients. More of these enhanced services will be rolled out over the next year as the integration continues.
Schwab's competitive advantage will be enhanced through this marriage by taking out one of the major competitors in an industry that is expected to see further consolidation. That has already begun, with Morgan Stanley (MS 1.63%) closing on a deal to buy E*Trade in October. Both of these behemoths will be battling with traditional players, like Fidelity, Vanguard, and Merrill. But the game-changer in the industry has been Robinhood, which moved the industry to free trading and has been chewing up market share by appealing to younger and first-time investors.
Schwab is well aware of the challenge. In response, it not only eliminated trading commissions, but it was the first major brokerage to offer fractional trading through its Schwab Stock Slices service, which allows people to buy fractional shares of larger-priced stocks. Fidelity and Robinhood followed close behind with their own fractional trading platforms. Schwab officials said it was introduced to appeal to new, younger investors, and to "democratize" investing.
Competitive advantages
Schwab has long had a competitive advantage over its peers with its cost efficiency. It has maintained high profit margins over the past decade (in the 30% to 40% range), which is well above the average for the financial sector. Even during the downturn, it has kept a 36% operating margin, down from 45% a year ago. This merger with TD Ameritrade will ultimately serve to enhance this cost advantage through the scale and greater efficiencies gained through the integration. Schwab has always been able to innovate and react quickly to market shifts due to its efficiency and capital management -- as it has shown in the last few years moving to free trades and fractional share investing.
Schwab is in a great position to continue its market-leading position in a consolidating brokerage industry. The earnings might not show it for the next few quarters in this low-interest-rate environment and as the integration process goes on. I'd probably wait a few quarters for that price to come down a bit, but in the long term, this is a good investment.
