Charles Schwab Target: Strong Margins in 2016 on Lower Expenses



Improved efficiency

Charles Schwab (SCHW) reported a record pretax margin of 38% in the fourth quarter, its highest since 2008. In 1Q16, the company is expected to report continuing strong operating margins. These higher margins reflect healthy growth in investor services and banking. The company posted operating expenses excluding interest of $1.04 billion in 4Q15, compared to $997 million in 4Q14.

The company is focusing on expense discipline combined with scale and innovation to maintain margins and gather new assets. Its major expenses include compensation and benefits, professional services, and occupancy and equipment.

Here’s how a few of the company’s peers in the brokerage industry have fared with operating margins:

  • Interactive Brokers Group’s (IBKR) operating margin was 45.4%.
  • TD Ameritrade Holding’s (AMTD) operating margin was 41.1%.
  • E*TRADE Financial’s (ETFC) operating margin was 31.0%.

Together, these companies make up 10.8% of the iShares US Broker-Dealers ETF (IAI).

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Maintaining margins

Charles Schwab focuses on improving value for its clients and profitability for its stakeholders. Its total expenses as a percentage of average client assets have fallen at a faster pace over the past decade, compared to revenue as a percentage of average client assets.

Its expenses as a percentage of average client assets have fallen to 0.16% in 2015 from 0.32% in 2004. Revenues as a percentage of average client assets dropped to 0.26% in 2015 from 0.39% in 2004. This resulted in a recent pretax profit margin of 34%–38%, compared to 16% in 2004.

Overall, the industry is facing some margin pressures due to pricing pressures from greater competition as well as an increase in compensation expenses to push for more retail assets. Considering the technology- and advisory-focused solutions offered by Charles Schwab, operating margins around 40% can be healthy for maintaining investments as well as for profit distribution.

Continue to the next and final part of the series for a look at Charles Schwab’s dividends and valuations.


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