Charles Schwab: Buy While The Market Is Pessimistic

The Charles Schwab Corporation (NYSE:SCHW) investors got a scare in mid-June, as the leading financial services company provided its monthly update. CFO Peter Crawford informed investors to expect a 10.5% decline in second-quarter revenue at the midpoint as the company continues to face higher funding costs headwinds. Read our previous coverage on SCHW here.

While the update assured investors that its cash sorting challenges could have peaked, there are concerns that the impact on Schwab's earnings visibility could persist through 2024. Therefore, I assessed that the market could remain tentative over a quick upward re-rating in SCHW stock in the near term as investors assess the impact on its earnings power.

I think the market's anxiety over the company's ability to navigate these challenges makes sense. According to Seeking Alpha Quant, SCHW's "D-" valuation grade suggests it trades at a premium against its financial sector peers. However, its "A" growth and profitability grade could provide helpful clues to the market's optimism about Schwab's robust business model.

Morningstar reminded investors that the company's "massive scale and industry-leading cost efficiency" underpin its wide economic moat. As such, I think it's essential for investors to assess whether they are confident in the company's ability to recover from its cash-sorting malaise, even as the Fed remains hawkish.

Bank of America or BofA (BAC) highlighted in early June that investors should not understate the headwinds, as Schwab's "cash sorting issues may persist longer than expected, potentially extending into 2024."

Given the significant contribution of net interest revenue to Schwab's topline (more than 54% in Q1), investors will closely monitor the developments. Furthermore, SCHW's sum-of-the-parts or SOTP valuation framework indicates that its net interest revenue segment accounts for more than 55% of its valuation.

The revised consensus estimates suggest that Schwab's overall revenue growth could recover in FY24, following a 6% decline in FY23. Therefore, the trend in analysts' estimates corroborates with management's commentary that "realignment of client cash will likely subside in the second half of 2023." However, I assessed that the developments remain highly fluid, as seen in Crawford's caution over the company's second-quarter revenue outlook.

Moreover, Treasury Secretary Janet Yellen's recent commentary suggests that investors should brace for more pain as regulators are "preparing for a potential resurgence of the industry's earlier turbulence." While Yellen doesn't expect the banking crisis to be worse than what we experienced in March moving ahead, her comments indicate that earnings recovery would be highly uncertain in the near term.

With that in mind, SCHW holders must assess whether dip buyers have been confident in bolstering the support for its bottoming process since it fell to lows last seen in late 2020.

I assessed that dip buyers had returned confidently, supporting SCHW's bottoming process since its March 2023 lows.

As seen in SCHW's long-term chart above, the stock remains in a long-term uptrend, even though its momentum has weakened. However, as long as dip buyers continue to support its March 2023 lows from being decisively breached, it should attract long-term investors to return confidently as SCHW consolidates along the current levels.

Regaining support above its 50-month moving average or MA (blue line) will need to be carefully watched, as it would portend a continuation of its bullish bias. Hence, it should be clear that SCHW is not out of the woods, even as it consolidates. Despite that, high-conviction investors should find the current levels attractive, as SCHW's adjusted forward P/E of 16.9x is still well below its 10Y average of 21.8x.

Therefore, unless SCHW fails to retake its bullish bias over the next four to six months, investors should find the current levels attractive. However, if SCHW's momentum remains tepid, it could suggest that buyers aren't confident about buying management's optimism in its ability to recover in earnings power. Therefore, investors are urged to continue monitoring SCHW's recovery closely.

Rating: Maintain Buy.

Important note: Investors are reminded to do their own due diligence and not rely on the information provided as financial advice. The rating is also not intended to time a specific entry/exit at the point of writing unless otherwise specified.

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