More Than Trading Costs

Why Charles is my broker

Published on:
June 9, 2018
Last Update:

About The Author

Noam Ganel, CFA is the founder of Pen&Paper, a value-oriented, contrary-minded journal of the financial markets. Since 2010, Ganel works for Silvergate as Vice President in Capital Markets and provides advisory services to family offices,  private companies, and financial advisors on their capital allocation decisions.

Ads for stock brokerage accounts emphasize the difference in fees per trade. Merrill Edge charges $6.95 per trade and now offers a $500 cash bonus if you open a brokerage account with them. Ally Invest commission per trade is $4.95 and they offer cash bonuses of up to $3,000. Ameritrade offers additional platforms, such as thinkorswim, in which they allow advanced traders to trade complex stocks options and foreign exchange.

But are trading costs and promotional teasers the real issue? To me, how safe and sound the brokerage firm is and its relative size played a much bigger role in the decision where to open my brokerage account. Take E-Trade (ETFC), for example. In 2012, the company showed losses of $0.39 per share. And between 2008 and 2010, it had a whopping average loss of $7.31 per share.

Compare that to Ameritrade (AMTD) or Charles Schwab (SCHW). Ameritrade’s 10-year average earnings per share was $1.29 and the lowest earning per share was in 2011, at $1 per share. In the case of Charles Schwab, the 10-year average earnings per share was $0.92 and the lowest recorded earning was in 2009, at $0.68 per share.

Charles Schwab

I opened my brokerage account at Charles Schwab because commission from trading is a small percentage of the company's annual revenue. It means that the company focuses on other sources of income rather than getting customers to trade excessively. To me, that is a positive quality from a stock broker.

In year 2017 numbers: Charles Schwab’s revenue from commissions was $600 million, while Ameritrade revenue from commissions was $1.3 billion. Another way to look at these numbers is that commission-related income was about 7% for Charles Schwab, while it served 38% for Ameritrade and 19% for E-trade.

I also thought that Charles Schwab follows what founded the company - that all Americans deserve access to a better investing experience. In Guy Spier's recent annual report, after realizing that some of his investors were hit with a steep annual fee for the custody of an IRA account, he made an arrangement with Charles Schwab where his investors are charged only $250.

Charles Schwab is a larger financial services company compared to its peers. Why does size matter? First, some companies are too big to fail, which means that it is likely that the government will assist the financial institution at times of financial duress. Read: financial panic. And the Great Recession demonstrated the too-big-to-fail theory when the U.S. government provided capital for, and became an owner of, Ginne Mae and Freddie Mac.

Second, in the financial services industry, it is often the case that the larger the firm, the cheaper it can offer financial services for each customer. And if I am correct in thinking that financial size matters in terms of cost and risk, then Charles Schwab looks much better than E-trade or Ameritrade. In year 2017 numbers: Charles Schwab’s revenue was $8.6 billion compared to Ameritrade revenue of $3.6 billion or compared to E-trade revenue of $2.3 billion. 

How capital markets value the brokerage company should not be overlooked, either. Charles Schwab’s 10-year average earnings multiple ranged between 20 to 32 times. It was as high as 53 in 2010 and as low as 13 in 2008. Ameritrade’s 10-year average earnings multiple ranged between 15 and 24 times. It was as high as 33 in 2017 and as low as 7 in 2008. And for E-trade, the 10-year average earnings multiple ranged between 18 to 34 times. It was as high as 69 in 2011 and as low as 10 in 2014. Because E-trade showed a loss in the period between 2008 and 2010, the earnings multiple is absent from that period. In short, capital markets value Charles Schwab much more favorably compared to its peers.

What now?

"Many shall be restored that now are fallen, and many shall fall that now are in honor," wrote Horace, the Roman lyric poet, in the first century BC. And two thousands later, in our modern world, not much has changed. Anytime I believe that large financial institutions - such as Charles Schwab - are careful and prudent in holding my money, I go back and visit the Wikipedia entry on Lehman Brothers and read about their bankruptcy. If that does not do the trick, I then visit the entry about MF Global Inc., the 8th largest bankruptcy in U.S. history. And as much as I would like to believe these brokerage firms are here to stay, the Securities Investor Protection Corporation (SIPC) was not created for no reason.

In How The Securities Investor Protection Corporation (SIPC) Protects You, you can get a better understanding of what SIPC is. Or you can visit their website by clicking here.

Similar to the world of stock investing, risk often rests in the unknown. And one way to reduce risk is simply to know more and to make rational decisions accordingly. In the case of the brokerage account, I carefully read Charles Schwab’s 8-k reports every quarter. I look at whether the company is taking more risk, for example, by making senseless acquisitions (Ameritrade recent purchase of Scottrade is an example that comes to mind) and whether the liabilities side of the balance sheet has increased. I then go over the list of new client’s assets (Charles Schwab had $233 billion in 2017 compared to $139.4 billion in 2015), the number of brokerage accounts and, of most importance, the financial health of the company.

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