BMO Capital Markets published a report on the diversified financial sector on Monday. Analysts David J. Chiaverini and Richard Fellinger point to a significant uptick in volatility leading to an increase in the volume of equity trading over the last few months, with daily average revenue trades for discount brokers up 25-30% for the month of January and up 31% year over year.
The analysts rate the sector as Market Perform and rate discount brokerage Charles Schwab Corp (NYSE:SCHW) as Outperform.
BMO Capital Markets discount broker recommendations
Charles Schwab Corp (SCHW):
Chiaverini and Fellinger say Charles Schwab Corp (NYSE:SCHW) is the blue chip of the discount brokerage space, offering strong recurring revenues and significant earnings leverage given the likelihood of rising interest rates. The analysts elaborate on their Outperform thesis below. “We believe Schwab’s valuation does not yet fully reflect the benefit of a 100 bp increase in rates or a 200 bp increase (see Exhibit 1). The company’s robust level of asset-based earnings warrants a materially higher valuation multiple than peers, in our opinion. We believe Schwab’s enhanced client acquisition initiatives, such as 401(k) cross-selling and independent branch openings, should nicely complement its traditional means of generating client account growth. We also believe Schwab Index Advantage, the company’s index-based 401(k) offering, is gaining traction and could be disruptive to the industry for years to come.”
TD Ameritrade Holding Corp. (AMTD):
The BMO analysts rate TD Ameritrade Holding Corp. (NYSE:AMTD) Market Perform based on valuation, including the likely benefit of a 100 bp increase in interest rates over the next 12 months or so. Chiaverini and Fellinger argue that AMTD is still leader in the sector despite their rating. “Despite our rating, we continue to like its business model given strong double-digit asset gathering and low balance sheet risk with its relationship with TD Bank, which owns about 42% of the company. TD Ameritrade has produced the strongest and most consistent asset growth rates among the major discount brokers over the past several years. The company’s newer focus on advice-based asset gathering (including Amerivest and AdvisorDirect) should produce 25% revenue growth in this “third revenue” stream. In our view, the company remains the leader among the large self-directed firms for client equity and options trading.”
The report also rates E TRADE Financial Corporation (NASDAQ:ETFC) as Market Perform on a valuation basis. The analysts see the firm as the least promising investment of the big three discount brokers due to current relatively high valuation. “In addition, we believe the company’s late start in building an asset-based fee income stream limits multiple expansion relative to peers. We believe E*Trade has a good retail brokerage business and a solid brand, but near-term upside is limited in our opinion owing to valuation.”