Schwab: Is a Dividend Boost in the Cards?
The large increase in fourth-quarter net income was due to tax reform, but the strong revenue and operating income growth were due to positive trends in the company's business model and expense discipline.
Despite the increased uncertainty regarding the economic environment in 2019 and beyond, wide-moat-rated Charles Schwab (SCHW) posted strong fourth-quarter earnings, and we believe that shares are moderately undervalued. Schwab reported $885 million of net income to common shareholders, or $0.65 per diluted share, on $2.67 billion of net revenue for the December quarter. Compared with the year-ago period, net revenue grew 19%, operating income grew 27%, and net income grew 61%. The large increase in net income was due to tax reform, but the strong revenue and operating income growth were due to positive trends in the company's business model and expense discipline. That said, we anticipate that our current $57 per share fair value estimate for Schwab will decrease $1 to $2 as we incorporate a longer time horizon to reach a normalized level of interest rates, as well as to adjust for the decline in equity markets in the fourth quarter. Even so, we still believe the shares are undervalued, estimating that a share price in the low $40s would adequately compensate long-term investors for a near-term recession and a dip in interest rates. We should also note that the firm is likely to significantly increase its dividend in the coming year.
Changes in interest rates continue to be primary drivers of Schwab's earnings, so with the outlook for interest-rate increases becoming more uncertain of late it becomes more difficult to project earnings growth. As we saw last year, when $544 million in net interest income more than made up for a $108 million decline in asset management revenue, rising rates have been a net positive for Schwab. During 2018, interest earning assets increased 20% to $268 billion and Schwab's net interest margin expanding to 2.39% from 2.03% during the year ago period. Interest-earning asset growth was primarily driven by an increase in bank deposits, aided by the company's movement of money market fund balances into its bank.
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Michael Wong does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.