THREAD---A great article this morning---Charles Schwab Corp.
The Wall Street Journal -- April 7, 1999
Heard on the Street:
Schwab Becomes Symbol
Of Internet Bullishness
----
By Rebecca Buckman
Staff Reporter of The Wall Street Journal
At a huge team-building meeting last month for nearly all of Charles Schwab's 13,000 employees,
Co-Chief Executive David S. Pottruck implored his troops to keep innovating in their jobs.
"We don't have time to build bridges" to the next millennium, Mr. Pottruck declared in the speech at
San Francisco's Moscone Center, where 5,000 employees watched in person; the rest watched on a
worldwide video feed. Mr. Pottruck also read inspirational email from employees. "We take leaps.
We leap across chasms into new and unexplored territory," he said.
Lately, the same might be said of Schwab stock, which has fast become one of the signature stocks
of today's Internet-charged stock market.
In fact, Schwab -- which has the biggest online-brokerage operation -- is itself trading more like an
Internet stock than a stodgy brokerage firm, without even having to add a "dot.com" or an
exclamation point to its name.
Shares of the San Francisco financial-services company have rocketed 91%, splitadjusted, on the
Big Board since the start of the year, to yesterday's record close of 107 1/4 , up 3 7/8 , as it has
outshone other brokerage companies that have been around much longer. The stock has jumped
14% this week alone, amid a rally in online-brokerage-related shares.
Some analysts expect Schwab to split its stock again sometime after its annual shareholders' meeting
next month. A 3-for2 split went into effect only in December, shortly before Schwab's stock-market
value soared so high that it eclipsed that of Wall Street powerhouse Merrill Lynch. Schwab has since
built on that lead.
The stock has been, in the words of Goldman, Sachs analyst Richard Strauss, "a monster."
But how can it keep going? The stock is a stellar long-term performer, with investors rewarding the
company lately for plunging head-first into the Internet while keeping earnings steady. But even some
longtime Schwab bulls are shaking their heads at the stock's recent, sharp spike.
The shares are now trading at 88 times estimated 1999 earnings, which First Call Corp. reports at
$1.22 a share -- to say nothing of the price/earnings ratio on trailing 12-month earnings of 126. Both
figures are triple or quadruple the overall market's. While some of Schwab's online peers don't even
have a P/E ratio -- because they don't have earnings -- Schwab's multiple is much higher than those
accorded traditional brokerage firms, which usually run in the mid-teens. Schwab's revenue and
earnings, though, have each had a compound annual growth rate of 25% over the past three years.
But with rapid-fire "day traders" now fancying the stock, it's "trading on momentum to some extent,"
says Gregory Smith, who follows Schwab for Putnam, Lovell, de Guardiola & Thornton. "My fear at
these levels is, what if we get a quarter of sequential decline in revenue? I just wonder how investors
are going to react."
Much of Schwab's future is tied to the fickle Internet now. The frenetic online traders have pumped
up Schwab's core brokerage business with new commission revenue, at the same time that the day
traders are pumping up the Schwab shares as they pile into Schwab itself.
Even before this week's run, the stock has been such a highflier that longtime Schwab stockholder
Baron Capital felt pressure to sell some shares earlier this year, after the value of the firm's original,
1992 investment shot up 50 times in value. Baron, however, still owns about 17 million Schwab
shares.
And while Schwab has been a pioneer on the Internet -- it overhauled its business last year to fight
off lower-priced online brokers -- the firms on the other end of the brokerage spectrum are now
catching up. Traditional, "full-service" brokers like Merrill Lynch and PaineWebber Group are taking
the Web seriously and, in some cases, are already offering online trading.
Henry McVey, a financial-services analyst with Morgan Stanley Dean Witter, says traditional brokers
could be a "major threat" to Schwab, which until now has managed to straddle the gap between
more-expensive firms and supercheap discounters. Even Wall Street's venerable Goldman Sachs is
getting into the act, investing in an online investment bank and a new, electronic-trading system also
partowned by E*Trade Group.
But Mr. McVey, other analysts and fund managers remain bullish on Schwab's competitiveness.
Schwab has a history of reinventing itself to capitalize on new industry trends, they note, whether it's
cutting prices on the Internet or making a mark with its no-fee "supermarket" of mutual-fund offerings
from many firms. Now, it's finding a way to offer a virtual version of a full-service brokerage on the
Web, says Salomon Smith Barney analyst Guy Mozkowski. Mr. Mozkowski calls the strategy
"extremely ambitious."
Schwab works hard at staying nimble: It spent $5 million last month on its employee "VisonQuest"
event, which involved herding together employees in 10 different world-wide locations on a Saturday
for a teach-in on Schwab's role in the financial world. The meetings were organized by Ohio
consulting firm Root Learning.
Although employees gathered in intimate, 10-person groups to discuss competitors like Merrill
Lynch, E*Trade Group and Vanguard Group, Mr. Pottruck says the firm isn't targeting anyone --
just trying to offer new services for increasingly wealthy customers. "Our model at Schwab is the
Gap," he says. "We think about, how does the Gap serve customers well? How does Wal-Mart
serve customers well? Home Depot?"
Indeed, new Schwab television ads stress personalized, intelligent customer service. They position
Schwab as a competitor to full-service firms, not merely a "transaction specialist." In several ads, the
camera zooms in on the faces of young Schwab brokers, including one recent Harvard University
graduate who talks about how much he wants to contribute to the company.
Mr. McVey calls Schwab's strategy "creative destruction." That means "destroying your current
business model to come up with a new value proposition for clients. And the bottom line is, investors
love that," he says. Indeed, Schwab ranked fourth out of 1,000 companies surveyed for 10-year
stock performance in The Wall Street Journal's latest Shareholder Scoreboard.
Still, Schwab's recent earnings have been driven in part by eye-popping growth in its brokerage
business, which Putnam Lovell's Mr. Smith and other analysts don't figure is sustainable.
Revenue-producing trades in February were 69% higher than last year, while the company saw net
"outflows," or selling by investors, in its mutual-fund business. Though mutualfund buying picked up in
March, Mr. Smith speculates that many investors who previously bought mutual funds have switched
to hot individual securities, an activity often more profitable for Schwab than mutual-fund trading.
Of course, all brokerage firms catering to individual investors would be hurt in a stock-market
slowdown. And Schwab, with its large, fee-based fund business, is more insulated than online
brokers such as E*Trade and Ameritrade Holding (which rocketed 47% on Nasdaq on Monday in
the online-broker-stock frenzy before giving back some of that gain yesterday.
Schwab also may have a leg up on full-service brokers in the race to gain dominance on the Internet.
Unlike firms with armies of research analysts and highly paid stockbrokers, Schwab "doesn't have an
expensive infrastructure," says Goldman's Mr. Strauss. "So for them to charge $29.95 a trade, and
now 65% of their trades are done over the Internet, they're able to charge that amount and be
incredibly profitable. At a typical retail, full-commission firm, that's just not the case."
Agrees Ron Baron, Baron Capital's chairman: "Everyone is trying to catch Schwab, and no one can
come close."
THEY LOVE 'EM: Shares of Internet companies are mainly held by younger investors who expect
the moon: They expect rates of return more than twice those of all investors, finds a poll by
PaineWebber Group and Gallup Organization. And investors with less than $100,000 to invest
report higher proportions of investments in Internet stocks than investors with more than that,
suggesting that Internet speculation is a man-on-the-street game. Overall, only 15% of investors own
or have owned Internet stocks.
BEST WISHES
BILL |
