Charles Schwab Corp's Earnings Show Its Advantage Over E*Trade and TD Ameritrade

Schwab's emphasis on wealth management services seems to be paying off, even as trading volumes weaken

Matthew Frankel, CFP
Matthew Frankel, CFP
Jul 22, 2014 at 10:01AM

Instead of trying to directly compete with rivals like TD Ameritrade (NASDAQ:AMTD) and E*Trade (NASDAQ:ETFC), Charles Schwab Corp (NYSE:SCHW) has been increasing its emphasis on providing not just trading, but wealth management services, to its clients. And according to the company's recent earning release, it seems to be working.

Schwab's second quarter earnings rose 27% despite lower trading revenues, thanks to stronger fees from management and administration fees. Is this growth sustainable, or just a result of the strong market? And would Schwab still be doing so well if the correction the experts keep predicting were to arrive?

Strong growth and strong results
Schwab reported a profit of $324 million for the quarter, nearly 27% higher than a year ago on 11% higher revenue. And, to make the results even more impressive, consider that trading revenue actually fell considerably during the same time period. So how did Schwab do so well?

During the quarter, asset management and administration fees rose 10%, which includes things like mutual fund management fees and other fees for managing client assets.

Also, net interest revenue, the difference between the interest Schwab earned and the interest paid on client deposits rose by 19%, mainly because the client assets Schwab is managing grew by a similar amount. This is very important, as it represents 38% of the company's revenue during the quarter, which is why the strong growth here more than made up for weakness in trading.

Schwab's total client assets grew by more than 17% in the past year to just over $2.4 trillion, which makes sense considering the markets seem to be reaching new highs every day, but the growth is occurring in another important way as well.

Growing in the right way
In addition to Schwab clients' assets growing thanks to the strong market, it is also growing because of new deposits, which are much more vital to Schwab's long-term health.

When the market rallies like it has over the past year, it is entirely possible for a brokerage firm's assets to rise, even if more customers are leaving than joining the company. However, Schwab saw nearly $23 billion in net new assets (new deposits minus money flowing out of the company) during the second quarter, with $11.5 billion of this in the month of June alone.

Nearly 250,000 new brokerage accounts were opened during the quarter, a year-over-year growth rate of 3%.

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This is the type of growth that allows brokerage firms to thrive no matter what the market is doing, and should be looked at as a very positive sign for Schwab's stockholders.

Advantage over its peers
Unlike E*Trade and TD Ameritrade, Schwab is not terribly dependent on revenue from self-directed trading activity, and it's a good thing. Trading volume dropped 13% from the first quarter, and about 3% from the same quarter last year. However, the company's $212 million in trading revenue made up just 14% of the total.

Summer is typically the weakest time of the year for trading volume, so the third quarter probably won't be much better, but as long as the company's two main revenue drivers stay strong (net interest and fee income), it shouldn't matter too much to Schwab's bottom line.

In contrast, E*Trade depends on trading commissions for about 41% of its revenue, and TD Ameritrade is even more dependent on trading at about 46% . Only about 9% of TD Ameritrade's revenue comes from fee income, so even outstanding growth in other areas is unlikely to make up for a significant drop in trading volume.

The key takeaway
Schwab is growing in the right way, and the company has a much more diverse revenue stream than its peers. Therefore, Schwab is much less sensitive to fluctuations in trading volumes which can be very unsteady due to both seasonality and market ups and downs.

As long as more money is flowing in to Schwab's accounts than is flowing out, we'll see fee and interest revenue continue to grow over the long run, which represents the lion's share of the company's income.