Schwab’s shares: It’s riches to rags

Last year, Charles Schwab Corp. seemed to be snapping at the heels of Merrill Lynch & Co. Inc., the top U.S. brokerage company. It was raking in assets at a staggering rate. And its stock price was shooting up, hitting a high of $40.50 last summer.

Now the stock is so vulnerable that it can take a hit, observers say, even when a rival electronic brokerage house comes out with some bad news about trade volume. At the start of the month, Schwab (SCH) hit a 52-week low of $13.14.

For Schwab, on one hand, it’s about perception. And on the other, there is its steep valuation.

Despite the stock’s recent low, its price-earnings ratio was an eye-popping 32.20 after it had bounced up to $16.42 at the end of trading Tuesday. It ended the week’s trading Thursday at $16.84 per share, for a p/e of 33.73.

pummeled

Online broker-dealers had seen their share prices pummeled. As the Nasdaq Composite Index soared 6% last Tuesday, some of them took off. E*Trade Group Inc. (ET) of Palo Alto, Calif., and Ameritrade Holding Corp. (AMTD) of Omaha, Neb., jumped more than 20% from near their 52-week lows.

Schwab stands out. “I have it in on my screen with other e-brokers,” says Ken Worthington, an analyst with CIBC World Markets in New York. “But I look at it more as a traditional brokerage.”

“At $16, it’s still expensive,” he says, particularly as the company’s growth has ebbed. “They’re not going to see a 30% to 50% growth rate. They’re not worth as much anymore.”

“I haven’t been their strongest proponent,” says Mark Constant, an analyst in San Francisco with Lehman Brothers Holding Inc. “The stock is not as egregiously overvalued as it has been. But I’m still not recommending it.”

Schwab holds an unusual position in the market in that it can rate comparisons with the largest retail broker. That can cause conflicting perceptions of the company and affect its stock price, observers say.

During last year’s second quarter, for example, Schwab took in $26 billion in net U.S.-based assets, compared with $11 billion for Merrill Lynch. That came after the height of the bull market of 2000, when Merrill took in $59 billion compared with $53 billion for Schwab during the first quarter.

But some lump Schwab in the same class as pure online broker-dealers such as Ameritrade. When such broker-dealers report that the volume of their customers’ stock trades has gone down, Schwab can take a hit.

For Mr. Worthington, Schwab’s acquisition of U.S. Trust Corp. last year was key. Now it delivers financial advice, often in short supply from rival Internet brokerage services.

And Mr. Worthington adds that the company does deserve a premium over other online brokers because the company’s “management is so good.”

But the heady days of trading above $40 a share are not likely to resurface soon, observers say.

multiple eyed

On Nov. 3, Mr. Worthington downgraded the stock from a “strong buy” to a “hold.”

“At 15% growth, Schwab deserves a multiple of high teens or low 20s,” he says. A fair market value for the stock is close to $15.50, he adds, so to make money an investor should wait for it to dip to $12 or $13.

But the company’s bottom line is likely to fall prey to the same problems as those of other online brokers, one analyst argues.

“Across the industry, we’re downgrading online firms versus traditional bricks-and-mortar stock brokerages,” says Tracey Webb, a financial analyst with Weiss Ratings Inc. in Palm Beach Gardens, Fla. Weiss Ratings evaluates companies’ financial statements to give its ratings. Weiss does not look at price.

Ms. Webb last week cut the ratings of eight online broker-dealers, including Ameritrade and TD Waterhouse Group Inc. She slashed both to C-plus, from B-plus.

The online brokers are seeing ugly balance sheets, she explains. In the case of TD Waterhouse, its liabilities have risen 50% while its net capital has declined 50%, she says.

She won’t be able to report on Schwab until its annual report in June, she says. Her reservations, however, are strong. “It’s a gut feeling, but it’s a good chance” Schwab also will be downgraded, she says.