Charles Schwab (SCHW 0.13%) has faced pressure over the past year as multidecade-high interest rates weigh on the financial services company. The high interest rates have customers moving funds from their accounts, creating a cash-sorting issue for Schwab and leading to a dramatic decline in deposits over several quarters.
The financial services company has alleviated fears around its deposit flows. Still, the stock continues to trade at a discount to its relative history, and it looks like an intriguing value investment opportunity. Here's what investors need to consider before hitting that buy button.
Charles Schwab's deposit outflows have slowed significantly
Charles Schwab provides a wide range of financial services, including asset management, wealth management, brokerage, banking, and financial planning, focusing on a low-cost, customer-centric approach. The company has historically been a stellar stock for investors thanks to its prudent approach to credit exposure and efficient operations that drive solid profit margins.
It's been a challenging year for the company, which has struggled amid the rapid increase in interest rates. Since March 2022, the Federal Reserve has raised its benchmark interest rate by 525 basis points, the fastest pace of interest rate hikes since the 1980s.
Schwab has historically relied on low-cost funding sources like deposits for its efficient operations. However, the rapid increase in interest rates had clients moving their money from lower-yielding bank accounts into higher-yielding alternatives, such as high-yield savings accounts, money market funds, or certificates of deposits (CDs). Last year, bank account deposits for Schwab fell by 20%, and total client assets fell by 13%, which led to a double-downgrade of the stock in January by Bank of America analysts.
The worst deposit outflows occurred between August of last year and April earlier this year when the company saw a $50 billion decline in its deposit base. Since then, deposit trends have improved significantly, with deposits declining by $4.4 billion over the last five months.
The company continues to attract new funds as it steadily grows its asset management business
Charles Schwab continues to perform well in accumulating assets, which are vital to growing asset management fees. This year, the company has added $230 billion in core net new assets, including $46 billion in the third quarter alone. Total client assets have grown 18% year over year, while total asset management and administration fees have grown 11%.
Growing assets is key to Schwab's longer-term success, and the company has done a solid job of attracting funds thanks to its low-cost funds and customer-centric focus. Management expected to continue growing net new assets at a pace of 5% to 7% annually, driven by assets from both new and existing clients.
Here's how margins could improve from here
Charles Schwab's client cash sorting issues have waned in recent months, but the company continues to deal with the impact of higher interest rates. Net interest revenue for the year is down 5% compared to last year due to higher interest expense, and its net interest margin of 1.97% in the third quarter was down slightly compared with 1.94% last year.
However, there is optimism that the worst is behind it. According to CME Group's FedWatch Tool, markets are pricing in four interest rate cuts by the end of 2024. These cuts would take pressure off its net interest margin, which Schwab projects will improve to 3% by the end of 2025.
Charles Schwab is an excellent opportunity for value-focused investors
Despite positive developments in Schwab's deposit trends, the stock is still down 34% since the start of the year, and the valuation presents investors with an intriguing opportunity. Schwab has historically traded at a premium, but today, the stock is valued at 18.3 times earnings and 5 times sales, both of which are below the company's 15-year averages.
SCHW PE Ratio data by YCharts.
Charles Schwab has managed to navigate this challenging environment and should benefit from a pause in the Federal Reserve's aggressive interest rate hiking campaign.
The Fed hasn't raised rates at its last two meetings, and, according to Peter Cardillo, chief market economist at Spartan Capital Securities, "The fact that they left rates unchanged for the second time in a row suggests the Fed might leave rates unchanged in December, and if they do, that means the Fed is done."
If that's the case, then I believe Charles Schwab is an excellent buying opportunity today.
