A Form 4 filed with the SEC has disclosed that Charles Schwab Corp (NYSE:SCHW) Board member Stephen Ellis directly purchased a bit less than 12,000 shares of the company’s stock on July 18th at an average price of $21.45 per share. This brought Ellis’s total direct holdings of Charles Schwab Corp (NYSE:SCHW) to over 16,000 shares and therefore represents a significant percentage increase in his exposure to the company. Economic theory states that insiders should prefer diversifying their wealth as opposed to taking on more company-specific risk in this way unless the insider is particularly confident in the company’s prospects. Studies do in fact show a small outperformance effect for stocks bought by insiders (read our analysis of studies on insider trading).
In the second quarter of 2013, total revenue increased slightly versus a year earlier. However, earnings were actually down for the quarter even before taking into account the payment of preferred stock dividends, and so earnings per share fell to 18 cents from 20 cents. With the company having experienced essentially flat profits in the first quarter of 2013 from a year ago, net income growth is now negative halfway through the year. This poor performance on the bottom line should be of concern to Charles Schwab Corp (NYSE:SCHW) investors: following a 72% increase in the stock price over the last year, it currently trades at 31 times trailing earnings, a valuation at which the market is pricing in high EPS growth over the next several years. Wall Street analysts estimate 87 cents per share in earnings for next year, which would be up 19% from their forecasts for 2013; even then the forward P/E is 25.
We track quarterly 13F filings from hedge funds and other notable investors as part of our work developing investment strategies (for example, we’ve learned that the most popular small cap stocks among hedge funds earn an average excess return of 18 percentage points per year). According to our database, Christopher Hansen’s $2.7 billion hedge fund Valiant Capital owned 3.7 million shares of Charles Schwab Corp (NYSE:SCHW) as of the end of March (see Hansen’s stock picks). Brave Warrior Capital, a hedge fund managed by Glenn Greenberg which tends to concentrate its holdings on a small number of stocks, reported a position of 8.8 million shares (find Greenberg’s favorite stocks).
The closest peers for Charles Schwab Corp (NYSE:SCHW) are E TRADE Financial Corporation (NASDAQ:ETFC) and TD Ameritrade Holding Corp. (NYSE:AMTD). Markets are optimistic about these companies’ prospects as well, and as a result they are valued at 21 to 22 times forward earnings estimates. Each of these stocks has also more than doubled the S&P 500’s return over the last year.
TD Ameritrade matches Charles Schwab Corp (NYSE:SCHW), however, in seeing only modest improvements in both revenue and net income in its most recent quarterly report compared to the same period in the previous fiscal year. eTrade has been even worse off, with its recent reports showing a decline in business. That company also carries a good deal of leverage, and partly as a result of that it is highly exposed to movements in the overall market with a beta of 2.4.
Other investment brokerages aimed at smaller customer bases are LPL Financial Holdings Inc (NASDAQ:LPLA) and MarketAxess Holdings Inc. (NASDQ:MKTX). Conditions have been considerably better at these two companies. LPL, which focuses on providing a platform for financial advisors, experienced a significant rise in income in its last quarterly report compared to the first quarter of 2012, and even though this was mostly from higher margins its revenues were still up 8%. Its trailing earnings multiple is 25. MarketAxess is also fairly expensive in terms of its trailing results, about in line with Charles Schwab’s valuation, but that company (which provides a brokerage platform for institutional investors trading fixed income investments) recorded close to a double-digit growth rate in sales with slightly wider net margins as well.
We wouldn’t recommend imitating this insider purchase at Charles Schwab, or buying the other individual investment brokerages, as the valuations are quite high considering recent performance. LPL and MarketAxess are also expensive in terms of their trailing P/Es, even in terms of their recent growth rates, and so it would probably best to avoid them as well at least for now.
Disclosure: I own no shares of any stocks mentioned in this article.
