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Bear Of The Day: Charles Schwab (SCHW)

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The trading platform battle is quickly heating up with America’s largest brokers completely cutting out trading fees. Charles Schwab (SCHW - Free Report) , E*Trade (ETFC - Free Report) , and TD Ameritrade (AMTD - Free Report) all announced that they would be offering commission-free trading. Investors are not happy about this decision and have been trading down these e-broker stocks since the announcement.

Investors and analysts are specifically pessimistic about Charles Schwab, the largest publicly traded electronic brokerage in the US. SCHW has fallen roughly 15% since its no-fee trade announcement, October 1st. The stock had been selling off all year as interest rates fall, and economic uncertainty shakes the market. This latest decision was icing on the cake of a struggling year.

Analysts have been dropping their EPS estimates and have pushed SCHW into a Zacks Rank #5 (Strong Sell).

The Space

The retail investor space has been changing rapidly over the past 10 years, with the traditional Wall Street stockbroker becoming archaic. The days of high testosterone, fast-moving exchange floors are almost entirely over as efficient computerized systems take the main stage in high finance.

Electronic brokerages were a revolutionary step in the evolution of retail investing. Early adopters like Schwab were able to capitalize on this. Investors could now buy and sell stocks on their own personal computers without a stockbroker having to mediate the transaction. This significantly cut costs for investors and made it easy for anyone, no matter the amount of capital, to play their hand in the equity markets.

The most recent change in electronic trading came with millennial’s favorite free-trading app Robinhood. This application started a cultural shift in investing for the young generation. The ability to trade with no fees has brought a substantial portion of the millennials to the equity markets.

Millennials are the largest consumer group and create a sizable market for electronic brokerages. With the younger generation being more interested in stocks than past generations, the longstanding e-brokerages want to take back that market. The zero-commission move was a play that these firms couldn’t avoid if they wanted to remain competitive in the field.

Business Impact

Charles Schwab doesn’t rely on trading commissions as much as some of the other e-brokers, but it will still impact 7% of its revenue. The move of investor capital into passive funds like ETFs and index funds is hurting the firm’s asset management segment. Falling interest rates are likely negatively impacting Schwab’s banking business as margins narrow.

Take Away

I would stay away from any electronic broker stocks until the full impact of their shift to free trading impacts the business. Robinhood can make money through selling users orders to market makers and through its premium platform. Schwab and its cohorts could offer similar premium packages to investors.

Wait for SCHW’s earnings report on October 21st for more color on the impact of this new move.

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