Charles Schwab (NASDAQ: SCHW) is one of the original brokerage firms to offer individual investors the opportunity to buy and trade equities at a discount. However, in recent years, Schwab has transformed itself from a discount broker focused on driving commissions into an asset management company, making money by charging a percentage of clients' assets as a fee for financial services. For the full year 2010, Charles Schwab reported a total revenue of $4.51B and a net income of $454M.
Schwab used its transformation to establish a firm foothold into the mass affluent marketplace, a segment which represents 60% of the $25 trillion in U.S. retail investing assets. With this focus on mass affluent customers, Schwab has carved out a unique position between the discount and traditional brokers. The downside is that Schwab faces competition on multiple fronts, especially as it continues to expand into areas such as 401(k) management, mortgages, and full service financial consulting.
Schwab Investor Services (SIS) provides retail brokerage and banking services to individual investors, as well as 401(k) and other retirement plan services to corporations. Its offerings range from self-directed research tools to full service financial consulting.
Schwab was one of the first companies to offer services, such as trading tools and marketing support, to independent investment advisors (IAs). Schwab is currently the largest provider to independent investment advisors at more than double the market share of the next largest competitor. This customer segment accounts for approximately one quarter of revenues and earnings. This division also includes Advisor Services and Corporate and Retirement Services.
Asset management and administration fees - include mutual fund service fees and fees for other asset-based financial services provided to individual and institutional clients. Schwab earns mutual fund service fees for shareholder services, administration, investment management, and transfer agent services provided to its proprietary funds, and recordkeeping and shareholder services provided to third-party funds.
Net interest revenue is the difference between interest earned on interest-earning assets and interest paid on funding sources. Net interest revenue is affected by changes in the volume and mix of these assets and liabilities, as well as by fluctuations in interest rates and portfolio management strategies.
Trading revenue includes commission and principal transaction revenues. Commission revenues are affected by the number of revenue trades executed and the average revenue earned per revenue trade. Principal transaction revenues are primarily comprised of revenues from client fixed income securities trading activity. Factors that influence principal transaction revenues include the volume of client trades, market price volatility, and competitive pressures.
Schwab, like all asset management firms, generates revenue on assets by charging fees and gaining interest on the money it manages. Revenues based on commissions are susceptible to swings in the stock market, which are linked to general economic conditions. In a bearish market, the trading volume is relatively low and this in turn decreases revenue from commissions. On the flip side, an upturn in the market will increase trading volumes and hence commission revenue for Schwab. In periods of economic uncertainty, trading volumes can spike significantly, reflecting investors' apprehension about the future of the economy. Commission revenues are a function of trading volume and price per trade. The key volume driver measured by brokerage firms is daily average revenue trades, or DARTs. Commissions will become increasingly important to drive revenue due to mounting pressures from other discount brokers and retail banks. Given that fees and commissions account for the largest portion of revenue for its overall business and that those revenues are decreasing, Schwab has continued to emphasize "upselling" higher margin products, such as its own mutual funds, comprehensive financial consulting, and 401(k) management.
The primary drivers of asset accumulation are the number of total clients and average assets per client. Schwab has leveraged both drivers in recent years by going after the mass affluent investors, an important customer segment that represents about 60% of the $25 trillion in U.S. retail investing assets. Mass affluent clients have between $100k and $1 million in investable assets and it will be important for Schwab to continue to pursue them in order to grow its asset base. Currently, Schwab holds about $120k for its average retail client and has aggressively marketed to this segment.
Schwab continues to make money from trading commissions and, increasingly, asset management by serving two major customer segments: individual investors and independent investment advisors (IAs).
Schwab makes money primarily from two sources: assets and trades. While Schwab has historically been a discount brokerage firm focused on generating revenue from trade commissions, the company has gone through a fundamental shift. This change places Schwab closer to the traditional brokerage firms focused on asset accumulation than the discount brokers that depend heavily on commissions from trade.
Market volatility and cycles affect Schwab's business as it does all brokerage firms. However, Schwab's shift to asset management allows it to be relatively less exposed to declines in transactions compared pure to discount brokers in case of a slowdown in the equity markets.
Charles Schwab's largest competitors are:
SCHW competes against smaller brokers such as ETFC, AMTD, and RJF.
One recent trend that may have a significant impact on all discount brokers is the entrance of retail banks Bank of America (BAC) and Wells Fargo (WFC), both of which announced fee-free trading in late 2006. While these banks do not have robust trading offerings compared to discount brokers, Bank of America and Wells Fargo have a strong foothold in the financial services marketplace; Bank of America alone has banking relationships with 50 million—or half—of all households in the U.S..
Schwab leads the niche institutional market with its Schwab Advisor Network. Its closest competitors are Fidelity and TD Ameritrade.