Monday, September 19, 2005

Return to Quality: The Redemption of Charles Schwab

Last Thursday, Charles Schwab announced it was cutting back heavily on fees.

Little late to the party, but we embrace the news anyways, Chuck.

The online brokerage was a cash cow during the Bubble, but after the burst, the firm witnessed a customer exodus as investors flocked into the open arms of cheaper discount brokers like Ameritrade (AMTD) and E-Trade (ET).

That was the first problem.

The second one was that around the same time, Schwab (SCH) went on a costly acquisition spree, led by chief value destroyer Dave Pottruck.

Schwab's solution to the market downturn was to charge the few remaining loyal customers even more.

Ya, that worked.

The stock price took a nosedive and SCH fell off most analyst's radar screens.

Until now.

Friedman Billings Ramsey just upgraded the stock, and we think over the next 6 months, the remaining bears (nearly every analyst on the Street has a hold on the stock) will follow suit.

We still hate the online brokerage industry -- swamped as it is in price wars -- that Schwab represents.

However, SCH is a great management-driven momentum play.

Pottruck's ouster earlier this year is a blessing we cannot ignore.

With Chuck at the helm again, we think the incentive to increase shareholder value will never be as great as it is right now.

Consider Chuck's remarks at the latest shareholder meeting:
Currently there are about 30 million households across the U.S. that have between $50,000 and $1 million to invest. I consider that the center or the "heart" of the American investor population. We serve about 10 percent of them. I see no reason why we shouldn’t aim to increase our share to 15 percent or even 20 percent of the market over the next 10 years.
We believe SCH will outperform its rivals if Schwab can figure out how to compete on quality again.

So there -- we said it.

2006 will be a turnaround year for the company, from who we expect nothing less than earnings acceleration as the company streamlines its core business.

Quite the gamble on our behalf, since Schwab has dashed up our totem pole from a Sell to a Strong Buy Rating virtually overnight.

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