Charles Schwab (SCHW 0.13%) has had a challenging year. The financial services company saw a sizable fall in deposits during the past year, leading to a downgrade by analysts early in the year. Then the failure of several regional banks had a ripple effect across the sector, leading to a sell-first, ask-questions-later effect for most financial stocks.
For years, Charles Schwab has displayed stellar management and excellent profit margins and has sold at a premium to competitors. Following a solid quarterly earnings report that quelled investor concerns, the stock is now up about 49% from its low point in May. Here's what you should know about the company and whether it's a solid buy today, even after its big run-up.
A declining deposit base spooked investors during March's banking fiasco
Charles Schwab provides asset management, wealth management, brokerage, banking, and other financial advisory services. One area where it struggled explicitly over the past year is declining customer deposits.
Inflation forced the Federal Reserve to aggressively raise its benchmark interest rate over the past year. From March 2022 through May of this year, the central bank increased the federal funds rate from near zero to 5.25%. This benchmark rate hasn't been this high since July 2007 and has created opportunities for investors to earn higher yields on safe investments, like money market funds and certificates of deposits.
Data source: YCharts.
This has hurt Charles Schwab, which was slow to adjust to the higher interest rates. Customers could earn higher interest elsewhere, and they have been making the move from Schwab during the past year in a phenomenon known as "client cash sorting." Last year, the financial services company saw its deposits shrink by $115 billion, or 17% of its total deposit base. As a result, analysts at Bank of America gave the stock a rare double downgrade in February.
While deposits were already under pressure, SVB Financial's Silicon Valley Bank and Signature Bank's failures in March made investors extremely critical of any financial companies seeing outflows in deposits. At one point in March, Schwab stock had lost more than 42% of its value as investors rushed for the exits.
Schwab's shrinking deposit trend looks to be abating
The last two quarters have quelled investor concerns about Schwab's declining deposit base. In the second quarter, the company saw its deposits decline 6% from the previous quarter. When we dig a little deeper into the numbers, you can see that the decline in its deposit base accelerated in February and March, both of which saw 5% declines month over month. In the past three months, the decline has slowed precipitously, and in June, its deposits were down just 0.2% from the prior month.
Data source: Charles Schwab. Chart by author.
As Schwab's deposit base stabilizes, investors have reason to feel optimistic. The Federal Reserve has signaled that it may be nearing the end of its aggressive interest-rate hiking campaign.
In June, the Fed decided against raising its benchmark interest rate for the first time in nearly a year and a half. According to the CME Group's FedWatch Tool, markets are pricing in just one more rate increase of 25 basis points (0.25%) before the end of 2023, with rate cuts coming in 2024. Without too many additional increases, the worst of Schwab's declining deposit base may be behind it.
A solid stock to hold long-term
For now, it appears Schwab's client cash sorting issues have diminished. While it still faces some risks of continuing outflows as interest rates stay elevated, it likely won't confront the same headwinds in the next year as the Fed pauses -- or at least significantly slows -- its rate-hiking cycle.
Data source: YCharts.
Even after the run-up in recent months, Schwab's stock still trades below its 10-year average price-to-sales (P/S) and price-to-earnings (P/E) ratios. While the valuation isn't as appealing as it was back in April, the company has done an excellent job of navigating a challenging environment -- making it a good stock to buy and hold for the long haul.
