Chuck Makes Less of a Buck

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Shares of discount brokerage Charles Schwab (NYS: SCHW) fell slightly as the company reported uninspiring results for its first quarter of this year. Revenue and net profit matched analyst expectations, more or less, but that meant declines in both of those key line items. A peek behind the numbers, though, reveals a few reasons for continued optimism despite those drops.

Giving the client a break
The big reason for the shortfall was fee waivers. For several years, Chuck has given its clients a break on fees if they're invested in the company's money market funds. This is because interest rates are so meager that investors are lucky to get much of any return at all from such vehicles. So if those fund holders were charged even modest fees, they'd run the risk of losing more than they take in from returns.

What's good for the client is lousy for the bottom line. Schwab forgave $163 million in money market fund fees this past quarter, which was an unnerving 46% increase from the first quarter of 2011. Had the firm not forfeited that money, it would have added impressively to the quarter's top and bottom lines, which instead came in at $1.19 billion and $195 million, respectively. The latter represented a stark 20% fall from the same quarter a year ago.


The forfeiture wasn't compensated by the company's trading activities. Nobody in this business is getting rich from their wire house services, and Schwab is no different. The year-over-year increase in trading revenue for the quarter was microscopic at less than 1% to $243 million. The quarter-over-quarter rise was a little higher at 4%.

Additionally, the derivatives broker Schwab bought last year, optionsXpress, was slapped with charges by the SEC. The government body accuses four optionsXpress employees and one of its customers of scheming to sell short positions it didn't really hold (i.e., "naked" short selling). A Schwab spokesman emphasized his firm's compliance with the SEC's investigation and pointed out that the alleged scheme happened before the Schwab acquisition. Still, Chuck will probably not escape some guilt-by-association sentiment in the market on the back of that bad news.

Reasons to be cheerful
Schwab's headline-grabbing figures didn't look so hot. Nevertheless, there were a few critical numbers that sizzled nicely. The company saw a nice rise of around 240,000 new brokerage accounts in the first quarter. A quarter of a million fresh accounts is definitely a positive showing, especially considering that the number was almost 20% higher quarter over quarter and 7% above that of Q1 2011.

The company also continues to grow its client assets, which saw quarterly and annual rises of 11% and 9%, respectively, to total $1.8 trillion. Non-interest expenses, meanwhile, were kept in check. They rose only 2% from the previous quarter.

More crucially, the company still stacks up pretty well against the competition. In spite of the slide in bottom line, Chuck still boasted a net margin of more than 16%. This is more than can be said for an investment bank behemoth like Morgan Stanley (NYS: MS) , which posted a loss and saw a nasty revenue drop in its most recent quarter.

Coping with peer pressure
At heart, Schwab is a discount brokerage, so competition in that niche of the market is always going to be tougher. Even so, and with its uninspiring recent quarter, the company's still managing to go toe-to-toe with its low-commission peers. Although it's beaten by TD AMERITRADE (NAS: AMTD) in terms of net margins -- that company rather consistently hits around 23%, both quarterly and on an annual basis -- Schwab edges its rival on an anticipated two-year EPS growth basis, 23% to 19%.

E*TRADE (NAS: ETFC) is better in that metric, with analysts expecting the company to increase EPS by 35% over the next 24 months. Its margins, however, are relatively weak, and it is only recently recovering from an uncomfortable history of posting losses. Plus, investor hopes that it'll be a takeover play seem to be fading rather quickly.

So despite the dips in some of its crucial financials, Schwab still has some strength it can build on and is managing to keep in the game. Considering that, we shouldn't be surprised if those revenue and net profit figures bounce back in subsequent quarters.

Speaking of financials, we've got a line on which ones the big-name investors are interested in. For the details, download our free report, "The Stocks Only the Smartest Investors Are Buying."

At the time this article was published Fool contributor Eric Volkman owns shares of TD AMERITRADE. Motley Fool newsletter services have recommended buying shares of Charles Schwab, TD AMERITRADE, and Goldman Sachs. Motley Fool newsletter services have recommended creating a bull put spread position in TD AMERITRADE. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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