The Business Of

Banking | Charles Schwab | What Do They Do With Their Profits?

Morning All!

Yesterday we put together Charles Schwab’s costs with their revenues. I noticed a slight error in yesterday’s newsletter – apologies! I said Charles Schwab had 35 million employees… rather than 35 thousand. 35 million would be half of the UK ha! But anyway, we’ve covered a fair amount this week. So let’s have a quick recap…

• Bigger Than Hargreaves: Schwab is a top 2 brokerage globally. Its ~35m accounts is ~20x bigger than the 1.8m Hargreaves - UK’s #1 brokerage – has!

• Bigger Than Barclays: By investing the idle cash in their users’ accounts, Schwab made $10.7bn from NII! Compared to £10.6bn Barclays made in 2022!

• Bigger Than Goldman: Goldman’s 33% EBT margin is very good. But Schwab’s 45% margin showed us how profitable the broker business model is!

And speaking of margin. It is a Thursday morning. Which means it’s time to take a look at our famous TBO EBIT Margin ranking! Below, we can see our ranking updated to include Charles Schwab. And what a beautiful sight that is – 45%, with only the Taiwanese semiconductor giant, TSMC, ahead of them!

But I have some other pretty incredible news. Whilst Charles Schwab’s margin of 45% is clearly incredibly good. There’s another company which we’ve mentioned a few times this week who have even higher margins! Hargreaves Lansdown! In 2022, the UK brokerage company had a hardly believable EBT margin of 55%! That’s higher than TSMC!

Now, that is clearly something to talk about. We’ve looked at >20 companies now on TBO and Hargreaves Lansdown is the first company we’ve seen with a >50% margin! So, tomorrow, we’re going to do a little deep dive into Hargreaves and see how the UK brokerage compares to Schwab.

And for those of us interested in investing, I think tomorrow’s newsletter comes at a pretty good time. Because Hargreaves’ share price is down a massive 71% from its peak in mid-2019! Tune in tomorrow to find out why!

Right, let’s get onto cash and see how Schwab uses all their profits!

Are Schwab Doing The Same Thing As Barclays?

So, to kick us off, let’s as always look at the waterfall chart below. Which shows us how Charles Schwab has spent their cash from operations (CFO) since 2006. Now, what do all those bars actually tell us?

Well, from 2006-2022, Charles Schwab made a cumulative $50bn in CFO. On top of this, they had $359 billion of cash come in, in the form of bank deposits. This is what we talked about on Tuesday. With the company treating the idle cash in their customers’ accounts as their own deposits. And we can see below - with that big orange/brown bar - Schwab invested most of that idle cash into securities (government bonds, etc). So the big blue and big orange/brown bars cancel out!

But then the next question is - why haven’t Charles Schwab done more with their cash? Let’s do a bit of adding and subtracting. They made $50 billion in cash from their operations. Add the $359bn from bank deposits. Minus the $353bn from securities. Minus the $12bn from dividend payments. Then add $6bn from ‘other’. And what does that equal… $50 billion!

What does this mean? Well, it means that Charles Schwab have basically been stockpiling all the cash they’ve made, on their balance sheet! And this is pretty much exactly what we see in the chart below. Back in 2006, Schwab has ~$5bn in cash. And by 2022, this cash balance had increased handsomely to ~$59bn!

Now, some of us might be thinking - ‘ah this makes complete sense. We saw Barclays do a similar thing. The UK bank needed to make sure they had enough cash on hand to deal with all their customers’ spending and cash withdrawals. So Barclays increased their cash balances a lot. Charles Schwab also need to make sure they have enough cash on hand to deal with withdrawals - and so that’s why they’re increasing their cash balance… right?’

Well, yes - this makes sense, and it’s partly correct. But this is only half the story… maybe not even half! To really understand the full story, we actually need to look at Hargreaves Lansdown!

26% vs 86%. Hmm Something Looks Odd…

Okay, so if we’re saying that Charles Schwab isn’t paying out huge dividends because they need to increase their cash balances in order to handle the increasing number of client assets. And the possibility of customers withdrawing their funds…

… we should be seeing a similar thing at Hargreaves right? The UK broker has a similar business model. They’ve had strong growth in client assets. They’d also need to pile up cash on the balance sheet right? Well, no - that’s not what we see at all! As the chart below shows, whilst Schwab paid out only 26% of their profits as dividends since 2011. Hargreaves paid out a huge 86% of their profits as dividends!

Clearly not as much cash stockpiling going on at Hargreaves! So this begs the question… what on Earth is going on?! Why can Hargreaves pay shareholders such high dividends, whilst Charles Schwab can’t?! Well, it’s all to do with WHERE Charles Schwab keeps their clients’ assets. Versus where Hargreaves keep theirs. And this difference, one - isn’t that well known and written about. So you can show off to your friends once you learn this! But two - it’ll be much easier to understand once we go through more of Hargreaves’ business model and its differences to Schwab’s.

So, because we’re diving into Schwab vs Hargreaves tomorrow - I think it’s actually best to leave the rest of this discussion till then! Trust me, it’ll be worth the wait! And by the way, don’t worry if the above is a bit complicated to understand at the moment. It’ll hopefully all make sense tomorrow!

23rd Nov 2023

Nigel Jacob CFA