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3 Reasons Charles Schwab Stock Could Rise

By Jay Jenkins – Mar 8, 2016 at 9:01AM

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The Charles Schwab Company has huge revenue upside, strong growth, and an exceptional culture.

Shareholders in The Charles Schwab Company (SCHW -1.06%) have been on a wild ride of late, with the stock rocketing wildly higher before promptly reversing several times just over the past year.

Looking past the volatility, there are many reasons shareholders should remain optimistic that the stock could rise. Here are three you need to know.

Huge revenue upside in rising rate environment
One of Schwab's largest businesses is managing money market funds for investors. When the Federal Reserve lowered interest rates to near-zero following the financial crisis, those money market funds were not able to generate enough returns from the low rates to cover the fees charged by Schwab and other money market funds. Instead of running off client assets by forcing these fund returns into the red, Schwab elected to waive the fees, keeping the fund's overall yield in positive territory.

SCHW Chart

SCHW data by YCharts

Today, interest rates have begun their climb back to more historically normal levels. As this happens, Schwab will be able to stop the fee waivers in their money market fund business, immediately boosting revenue that should translate almost directly to profit. The company is still operating the funds, after all, meaning the expenses are still incurred each quarter and year. The extra revenue should not drive any significant increase in costs and therefore provide an immediate boost to earnings.

The upside here is huge. Schwab waived $672 million in these fees in 2015, slightly less than the $751 waived in 2014. The company's 2015 total revenue would have been over 25% higher had those fees been collected, instead of waived.

Charles Schwab is a growth machine
Over the past five years, the Charles Schwab Company has grown its total assets by over 93%. That far exceeds the growth seen by others in the securities and asset management business. From the largest firms in the world like Morgan Stanley to more nimble, technology based players like E*Trade, Schwab's growth stands well above the rest.

SCHW Total Assets (Quarterly) Chart

SCHW Total Assets (Quarterly) data by YCharts

The balance sheet growth has matched strong growth in the level of client assets under management, a key indicator of the company's earning power. These assets represent the funds owned by clients that Charles Schwab manages directly or holds in its various brokerage and deposit services. From 2008 to 2015, client assets grew 127% to $15.1 trillion. Those new assets will continue to grow both from new client assets coming into Schwab's portfolio, as well as with long term increases in the stock market in general. The beauty of compounding interest benefits Schwab over the long term just like it benefits you and me.

This asset growth has been a result of Schwab's excellent customer service record, smart marketing, and effective strategy. There's no indication that any of these factors have or will change any time soon – the company's fourth quarter was a record for both net income and revenue. If this growth continues, I think it will help drive the stock higher.

Excellent management and culture
Schwab's potential for strong revenue and asset growth are quantifiable metrics that could spur the stock price higher. There are other, intangible qualities about the company that over the long term could be even more powerful.

Companies must create a culture to attract the best talent, successfully hire the right people, and then unify the organization's efforts to maximize value for customers and shareholders. Schwab succeeds at all three.

First, Schwab must create a culture where the best and brightest want to work. The company has successfully done that, and was even recognized for it this year as one of Fortune Magazine's "Top 50 Most Admired Companies" for 2016, ranking first for innovation and social responsibility in its industry.

Second, the company must hire the right people. The company's CEO, Walt Bettinger, takes this aspect of the job seriously, explaining in an interview this year how he determines which candidates have the right character and emotional intelligence to effectively lead at Schwab. When he evaluates a candidate, Bettinger will sometimes "meet someone for breakfast for the interview. [He] will get there early, pull the manager of the restaurant aside, and say, "I want you to mess up the order of the person who's going to be joining me. It'll be O.K., and I'll give a good tip, but mess up their order."

The objective is to gauge how the candidate reacts when something goes wrong. Are they empathic? How do they manage their emotions? How do they respond to this small adversity? This process, reflected throughout the organization, seeks to find people who are both qualified and capable of executing the customer first strategy that Bettinger calls "through clients' eyes."

That strategy is the third component required for the company's culture to help drive the stock price higher. Bettinger described the theory to investors in the company's fourth quarter financial report, saying "We know that when we do right by clients they will choose to do more business with us, and if we manage that trusted relationship with care it will help produce strong business performance."

Charles Schwab stock could go up for any of the above three reasons. If the company can get all three, then the sky is the limit for this company and its shareholders.

Jay Jenkins has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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